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U.S growth / inflation / equities / debt / gold

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    730 Posts.

    The U.S last night posted anualised GDP growth of 5.8%, hence ending some peoples fears of a sustained economic recession.

    I look at things a little differently.

    On the GDP news, the NASDAQ fell 2.9% and the DOW fell 1.18%.

    U.S investors are now afraid that inflation is on its way up. When inflation rises, interest rates rise.

    Three point are important to note: U.S interest rates are at thirty year lows; the government recently passed tax cuts worth hundreds of billions of dollars and the U.S economy has been artifically supported through government spending on defence, security and infrastructure, again totalling tens of billions of dollars.

    So effectively, the interest rate declines have only contributed part of the increase in economic activity. It is difficult for me to extrapolate the degree by which economic activity has increased due to the other factors.

    Two immediate problems are evident. Firstly, increases in government expenditure and tax cuts have predominantly been funded through borrowing. With a smaller tax take, it only adds to U.S debt, which creates a viscious circle when decisions are made just to pay the interest.

    The second immediate problem is that slowing the U.S economy will take increases in interest rates. We all know how electorally unpopular that is. The choice is whether one increases interest rates to ensure lower inflation, or accepts a higher level of short term inflation. Remember though, that without the support of government spending and tax cuts, GDP would not have grown by an annualised 5.8% - therefore small interest rate rises may not be enough to prevent inflation.

    It is also important to note that the GDP figures are only one indicator. It will be interesting to assess the next employment and current account figures in the context of analysing the whole 'state of the economy'.

    What happens when inflation rises or when investors fear inflation?

    Gold enters the story. Gold has always been currency - to varying degrees. Historically, gold was the primary 'store of wealth'.

    It is fair to suggest that over the most recent decades, gold has been sidelined as an investment, whilst trillions have flowed in to global equities, mirroring the rise and rise of household capitalists.

    However, physical gold remains a means of storing welath. This has been demonstrated by recent buying by Japanese families, pushing the POG to sustain its' move above U.S $300.

    The point is this. People are buying physical gold to shield their wealth from inflation and falling currency values. This is increasing demand, causing short supplies.

    Alas, gold bugs have more to look forward to. The POG surpassed the $308 level yesterday and reached $312 in the U.S overnight.

    This activity will lead to investment buying. We've all heard the figures. If only a fraction of a fraction of global capital went into physical gold, the POG would easily pass US $600.

    The second factor for gold bugs to look forward to is the major institutions having to undo complex loan arrangements. Nobody knows just how much gold has been lent out on paper. But the POG is getting to a point now whereby those institutions have to retrieve the physical commodity or face billions of dollars worth of losses. This will be the key driver for the POG in the coming months.

    Hope you found my views interesting. Any opinions?

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