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Gold likely to remain in up-trend for years to come

by Wayne Cheveldayoff, 2006-05-11

The rise in the price of gold has recently been attributed to world political factors, such as Iranís defiant stance on uranium enrichment.

But even when world political tensions concerning the Middle East eventually subside, there is one underlying cause - the re-pricing of U.S.-dollar assets because of that country\'s unsustainable deficits - that is likely to continue to keep precious metals in an uptrend for years to come.

Itís not just gold and silver that have been affected. The U.S.-dollar prices of commodities such as copper, zinc, oil and gas, coal and uranium have climbed dramatically.

Countries that have these ďhard assetsĒ like Canada have seen their currencies appreciate against the U.S. dollar.

Even the rise in real estate prices worldwide can be traced to some degree to peopleís expectation that an upward swing in inflation, in other words, a devaluation of paper assets, is the natural consequence of the severe U.S. government and current account deficits.

The U.S. current account trade deficit is running at $800 million (U.S.) annually (about 7 per cent of GDP). This is how much more is flowing out of the country to buy imports to maintain U.S. living standards than is coming in from the sale of U.S.-made goods and services abroad.

Foreign companies and governments have been accumulating these U.S. dollars (more than $2 billion a day) and generally have been willing to re-invest in U.S. financial assets such as stocks and bonds, U.S. businesses or real estate.

But the attraction of U.S. assets has been wearing thin. Holders of U.S. dollars worldwide, including some central banks, are instead now choosing more often than before to accumulate gold or alternative currencies such as the Euro.

Itís just common sense. Why should they continue to prefer U.S.-dollar assets when their value is steadily dropping against virtually everything else?

To attract the capital, U.S. interest rates will have to go up (bond prices down) to give foreigners more incentive to put new money into U.S.-dollar bonds, or there will have to be other adjustments to make U.S. assets look like bargains, such as lower stock prices or a further depreciation of the U.S. dollar.

Strong U.S. economic growth and rising interest rates have been supportive of the U.S. dollar in the past year but the U.S. Federal Reserve may find it harder to navigate through the deficit mess in the coming years.

If the Fed were to continue to support the U.S. dollar with additional interest rate increases, U.S. stock and home prices would likely tumble, causing economic turmoil. If instead the Fed were supportive of stock and home prices (by holding down interest rates), the U.S. dollar would depreciate further.

Investors around the world are coming to the conclusion that the latter route will be taken. In a democracy, politicians choose what is less damaging to the voters. In the short-run at least, inflation is likely to be judged less damaging that rising unemployment.

In addition, Federal Reserve Chairman Ben Bernankeís public statements point in this direction. He has stated that the Federal Reserve caused the great depression of the 1930s and he would not let that happen again.

Obviously, when the deficit problem turns into a crisis, the Federal Reserve will print money and keep interest rates on the low side in order to keep the economic wheels turning, even if it means higher inflation.

If you are sitting in the United States, you may conclude this is the right thing to do. But if you are anywhere else, you would be asking yourself why you should continue to hold U.S.-dollar assets if their fate is a further loss of value.

What has happened historically is that assets in a country with a high current account deficit lose value relative to the assets in countries that donít have such problems. As investors look for ways to preserve their wealth, the value of precious metals also goes up relative to the assets of the country with a high current account deficit.

Recent developments are indicating that history is repeating itself. U.S. assets, particularly financial assets, are losing ground against all others.

The process is likely to continue for many years to come, and precious metals will be among the beneficiaries.

Wayne Cheveldayoff is a former investment advisor and professional financial planner. He is currently specializing in financial communications and investor relations at Wertheim + Co. in Toronto. His columns are archived at and he can be contacted at

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©2006 Wayne Cheveldayoff