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What On Earth Is Going On With Gold Now?

Recently we discussed the fact that short-term moves in precious metals prices shouldn't sway us in regard to how we view gold. This is because the fundamentals of gold are mostly long-term. There are some short-term plays that investors can seek in regards to precious metals. But the buy-and-hold strategy doesn't necessitate constant monitoring of gold's every move.

On the other hand, understanding these fundamentals, their implications, how they interact with economic pressures, political maneuvering and fiscal manipulations, all must be constantly studied, surveyed, weighed and considered from every angle we can surmise. Sometimes there are incredible opportunities, such as those we mentioned regarding miners. Any investors who took our cue on GDX, GDXJ or SIL (not that we were alone) could have realized gains of 8 to 20% in just a few weeks. SLV (silver) and GLD (gold), both of which track their respective metals, are gaining as well. As I prepare to post this entry gold is holding steady at the $1730 mark, with silver at $33.50, both basically tracking sideways.

So, why the sudden change? After considering Januaries past, I had expected this month to be a sort of calm before the storm, if anything. Instead, right here at the end, it's taken on a life of its own. This has offered investors some pretty amazing opportunities in the metals sector, as well as elsewhere.

The irony of it all is that the instigation for the recent shift in the markets came on the tail of President Obama's assurance that things were in hand regarding the economy. Anyone who pays attention to the economy at all understands that everything is, if anything, not well. But politicians present things in a certain way, often giving what they want the in a way that we want to hear them, in order to encourage greater public support.

The "last straw" event that led to the recent drop in the dollar and spike in precious metals was, of course, the announcement that came from the Federal Reserve the day after the President's State of the Union Address. Apparently our current inflation rate is acceptable to the Federal Reserve. Therefore, they've extended the status quo by another 18 months, assuring us that the dollar will continue to be printed, ad infinitum, at almost zero percent interest until 2014.

Thus, the eyes that were turned to the problems of the euro, and the gains that came as many fled euros for dollars, were hammered, not only by continued irresponsible fiscal policy, but by the promise that such hammering won't let up for at least two more years. In layman's terms, this means that dollars really can't increase in value and that anything tied to the value of the dollar must decrease in value as well.

Let's put this in perspective. As you are likely well aware, true inflation is much higher than the posted CPI. For 2011 the old SGS inflation rate (1980) was just over 10%, the newer formula (1990) was just over 6% (probably a very responsible number), but the currently used CPI sat at just 3%. If you had to issue COLAs, which percentage would you use? Some agencies use an even lower number, such as the Core CPI, currently at 2.2%. However, the Federal Reserve, in its infinite wisdom, has chosen to instead use what's called the "chain-type price index for personal consumption expenditures." Basically, it amounts to a lower, highly doctored, inflation rate; currently below the Fed's acceptable 2%, but barely, at 1.7%.

If the Federal Reserve is promising to leave things as they are, we can basically take that as a promise that the presses will run and the dollar will continue to decline in value at the same rate. In other words, there is a very real sense in which we've been promised that in two years, at the current rate, the purchasing power of the dollar will drop by:

· 21% - 1980 SGS

· 12.4% - 1990 SGS

· 6.1% - Current CPI

· 4.4% - Core CPI

· 3.43% - Fed's CPIPSE

Responsible fiscal policy necessitates higher interest rates to combat inflation. The Federal Reserve is stating that inflation isn't high enough to warrant higher interest rates. We'll discuss the horrors of inflation and the Keynesianism of current fiscal policies in other entries. For now, as you can see, we're not being given the whole story. Investors quickly recognized the writing on the wall. The Fed's promise to keep interest rates near zero necessitates a falling dollar. Furthermore, it's a promise that we have two more years to take loans at almost nothing. In other words, people will continue spending.

These are two dynamics at work right now. One - easy money that keeps wallets open and ready to continue spending. Two - recognition that the dollar will continue to be devalued as part of fiscal policy.

What happens when people are reminded that fiat currency is not a reliable store of value? They turn to true money, gold and silver. Without the Fed's announcement, we may have continued to experience the recent lull. With it, for now eyes are once again cast toward precious metals and other investments that aren't dependent upon the dollar for their value. There were other pressures as well, such as the current posturing in the Middle-east. But the final straw came with the Fed's promise to further debase the dollar.

What will happen now? I wish I knew. As we discussed recently, it's an election year. There will be efforts to suppress anything that makes the economy look bad. And there will be efforts to doctor anything that can make it look good. But we're early in the year and Americans have a proven propensity towards myopia. Letting the dollar settle now may provide for opportunities to increase its stature later in the year, influencing voters.

Perhaps this would be a good opportunity for us to consider what others are expecting in regard to gold's future. With this in mind, tomorrow I'll bring some statements from various financial advisories regarding predictions. Some are quite amazing.

For your prosperity,
J. Keith Johnson
The Gold Informant