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US debt downgrade imminent?

|Includes:AEM, EGO, GLD, Sprott Physical Gold Trust (PHYS), PSLV

US dollar Gold and silver prices fell slightly yesterday, as investors moved out of safe-haven assets on the back of the news that politicians in Washington had reached an agreement to raise the US government’s debt ceiling.

August Comex gold fell $9.30 (0.6%) to settle at $1,619 per troy ounce. The front-month silver contract lost 79.4 cents (2%) for settlement at $39.298 per troy ounce. Both metals recorded gains later in the day, however, on the news of weaker-than-expected US manufacturing data from the Institute for Supply Management’s manufacturing purchasing managers’ index, which fell to its lowest level since July 2009. Continuing weakness in the US economy will mean that the Federal Reserve will maintain its ultra-loose monetary policy, which is bullish for precious metal prices.

Assuming that the Senate votes through the proposed US debt deal (which would then be sent to President Obama to sign into law), the federal government’s debt “limit” will have been raised by $2.4 trillion. In exchange, Congress will reduce the deficit by over $1 trillion over the next 10 years, with a bi-partisan committee reporting later this year on proposals for a further $1.5 trillion in deficit reduction.

It must be remembered though that these supposed “cuts” are nothing of the sort. They are instead reductions in the rate of increase in federal expenditure. Under this plan, government borrowing will actually increase by over $7 trillion over the next decade. Furthermore, if the White House and Congress’s optimistic assumptions about GDP growth and interest rates are incorrect, the Treasury’s borrowing needs could be even greater.

Little wonder then, that world leaders – such as Russian president Vladimir Putin – are becoming more openly critical of this profligacy, while more and more influential establishment figures are saying that a US credit-rating downgrade is deserved.

Little wonder also that South Korea’s central bank has bought 25 tonnes of gold over the last two months, its first gold purchases since 1997-98, noting that “conditions were ripe” for an increase in gold holdings. Given the correlation between rises in the US debt ceiling and the gold price – evident from this chart– this seems like a good bet.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.