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Ride The Tide

One day, gold will be sold off and given up for dead. Analysts will warn that longs are cashing in, soon to be followed by a mass liquidation that will send gold back down to the low $800s.

And yet the next day, gold rallies back upward as investors somewhere, for various reasons, pile back into the yellow metal.

If it sometimes seems as if gold is simply bouncing around like a cork amidst the waves, it’s understandable. Many investors feel the same way.

But it’s a mistake. Because -- just as those who focus too closely on the bobbing cork can overlook the rising tide -- investors who see only gold’s daily gyrations can miss seeing the rising ocean of money that is lifting the metal ever higher.

Buyers Still Stepping Up

Frankly, the recent surges in gold demand seem to be physical in origin, as a growing number of investors/savers appear to view the metal at current prices as a relative bargain. Premiums in India, for example, show that buying there has been fairly robust on the recent price dips.

In addition, some of the dramatic rebounds we’ve seen recently have come even while the dollar has been rising. These price surges, which point toward big, deep-pocketed buyers rushing into the market, appear to represent both a large degree of short covering, as well as hedge buy-backs by major gold producers.

In fact, Buenaventura has announced that it closed out its entire hedge book with a payment of US$434 million to release 782,000 ounces committed for years 2010 to 2012. The news release gave no indication of the timing of the transaction, but a reference to a smaller hedge closeout announced in a filing on January 24 would indicate that this last, very large transaction occurred early in February.

It may have been an important factor behind the latest rebound, but it wouldn’t have been the only one.

The escalating credit crisis, the growing evidence of a U.S. recession, the Federal Reserve’s apparent willingness to lower rates and open monetary floodgates at Wall Street’s beck and call -- all this and more make a very compelling argument for gold investment right now.

As if that weren’t enough, these economic arguments are boosting gold demand at the precise time than new supply constraints are limiting gold supplies from both mines and central bank coffers.

More specifically...

The power crisis in South Africa is dramatically reducing gold production, and there is no quick solution in sight. After a brief shutdown of major African gold mines, most importantly those of AngloGold Ashanti, Gold Fields and Harmony, the crisis was thought to have passed as Eskom, the South African power monopoly, promised 90% of normal operating power.

But hopes of maintaining near-normal gold production were quickly dashed. Rolling blackouts have led some mines to shutter operations entirely, rather than risk stranding miners far underground. Gold Fields states that even at 90% power, they would lose 20% of their production. AngloGold Ashanti reports that the power crisis has already cost 400,000 ounces of production, and going forward at 90% would cost 200,000 ounces annually.

With South Africa also a primary supplier of the world’s platinum and palladium, it’s not surprising that the reaction to this crisis has been most acute in the platinum group metals.

In short, a buying frenzy has been spawned by auto manufacturers desperate to secure supplies of platinum and palladium for catalytic converters. This demand, combined with tight PGM physical supplies and rampant speculation in futures, options and ETFs, has sent platinum and palladium prices soaring.

Of course, while supplies are not quite as tight in gold, the same power supply problems are hampering gold production, and helping to drive the metal higher as well. Plus, other problems -- ranging from escalating construction and production costs (Newmont just announced a huge cost increase at its Boddington Mine) to blizzards in China forcing power outages -- continue to plague gold production.

And there is a yet another primary supply constraint that is likely fueling this rally....

Central banks are running low on ammunition with which to attack the gold market. It was 10 years ago that we published The Gold Book, a stunning compendium of research and analysis by Frank Veneroso that revealed how years of gold sales and loans by central banks, spurred by a gold carry trade, had led to a huge accumulated “short position” in gold that could never be repaid.

In addition, Frank concluded that this continued trend of gold loans would, in about 10 years time, reduce central bank gold holdings to the point where they would no longer be able to provide enough metal to the market to restrain the gold price.

The result, he said, would be an explosion in the gold price to a level that would far overshoot the equilibrium price.

It’s been 10 years, and judging from the reduced level of official gold sales under the Central Bank Gold Agreement in recent months, we may have reached the turning point Frank predicted.

Importantly, as I alluded to in my “rising tide” analogy, these factors are all coming into play just as the global money supply is rapidly enlarging.

For years now, I’ve been warning you about the ramifications of competitive currency devaluations, as trade currencies around the world race for the bottom of the hill in a beggar-thy-neighbor attempt to gain even the slightest advantage over other exporters.

Other nations began the race, but the U.S. finally joined in. And then the sub prime crisis hit, throwing the interconnected global economies into peril...and forcing the devaluations into overdrive.

Even Europe, home of the last remaining staunch anti-inflationists, has now signaled monetary easing ahead.

But beyond accommodative interest rate policies, finance ministers are flooding their economies with new fiat currency, created either directly through the printing press or via credit creation. Ben Bernanke has dropped $114 billion in new money from his helicopter so far, and the European Central Bank has already provided an amazing $500 billion in credit to bail out its troubled financial institutions.

As the old saying goes, “A billion here and a billion there, and pretty soon you’re talking about real money.”

Of course, the “real money” people the world over are now talking about is gold. That’s the primary factor driving the metal’s relative value right now -- as the tide of paper money rises ever higher, it will continue to lift the ultimate currency to greater heights.

And this is why we need to ignore the waves that drive gold up and down so violently these days, and concentrate on the tide that is continually rising underneath.

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