Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

Precious metals prices tumbled today on news that China’s monetary authorities were taking steps to rein in the economy. Gold, which began the New Year on a very strong note, was off as much as $25 in New York trading.

With the China’s economy recovering smartly, the People’s Bank of China is taking action to dampen real estate and stock market speculation and pre-empt rising inflation expectations.

U.S. policy makers, unlike the Chinese, have no room to tighten policy. Indeed, as we get closer to the November mid-term Congressional elections, the probability diminishes that the Fed will nudge interest rates higher.

With high unemployment expected to hurt Congressional incumbents – and the Obama Administration worried about losing its majority in the Senate – the Federal Reserve will be under increasing pressure to hold policy steady until after the November elections.

Unfortunately, the Fed is between a rock and a hard place. Tightening policy to ward off inflation runs the risk that the economy will deteriorate so much that the “Great Recession” will be recorded in the history books as the “Second Great Depression.”

Without a doubt, and to the long term benefit of gold prices, the Fed, the Treasury, the Congress, and President Obama would prefer higher inflation to the alternative.

As a result, I believe we are heading into an extended period of stagflation – low real economic growth and high inflation – much like we saw in the 1970s. And, as we saw in the 1970s, gold will continue to appreciate for years to come.

This year alone, I expect gold to reach a high of at least $1,500 an ounce.

Moreover, gold’s bull market seems destined to continue for another few years, carrying the yellow metal to at least $2,000 and quite possibly $3,000 or higher before the bull market for precious metals comes to an end.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

The now ten-year old bull market in precious metals has seen the price of gold move up well beyond it previous historical peak near US$875 reached briefly in January 1980.

But silver has still not surpassed its all-time high of $50 an ounce — and even remains well below its current cyclical high of $21 an ounce reached in 2008 — leaving silver bulls disappointed but optimistic that huge gains are still ahead with the white metal ultimately reaching and surpassing its 1980 peak price in the years ahead.

Even as investment demand for silver has soared, in part due to the introduction of silver exchange-traded funds in 2006, global macroeconomic trends have cut deeply into silver jewelry and industrial use while photographic use, once the largest consumer of silver, has continued to lose ground to digital photography.

In the next decade, a rebirth of silver industrial demand, thanks to the emergence and growth of a number of new end uses, will join continued strong investment demand to push silver prices sharply higher with the white metal gaining not only against the dollar and other old world currencies but also outperforming gold.

Silver Mine Production

Meanwhile, silver mine production will remain relatively inelastic. To a large extent, silver is mined as a by-product or co-product of other metals (lead, zinc, copper, and gold) — and is dependent on mine-supply situation for these other metals and less on its own positive fundamentals.

Only about 30 percent of total silver-mine output is from primary production, that is from mines that are primarily silver producers, from mines that exist principally to mine silver. About 15 to 20 percent of silver mine supply is as a co-product and the bulk, about 50 percent, is mined as a by-product where the price of silver has little influence on mine economics and decisions to invest in mine exploration and development. Importantly, this means that the expected rise in the price of silver will not be countered by a concomitant rise in mine supply.

Physical Investment Remains Strong

Looking ahead, physical investment demand — for bullion coins like American Eagles and Canadian Maple Leafs, for small investment bars, and ETFs — will continue to expand in tandem with gold as growing numbers of Western investors seek safe-haven and hedge assets.

At the same time, growing numbers of Eastern investors and jewelry consumers — in China, India and elsewhere — will also accumulate physical silver, reflecting rising personal incomes, silver-friendly government policies, and the maturation of precious metals market institutions and infrastructure.

The perception of silver as a cheaper alternative to gold — as “poor man’s gold” as the metal is often called — and a growing recognition of the white metal’s increasingly bullish supply/demand fundamentals will also foster rising investor interest around the world.

On the investment side, gold has benefitted from a significant step up in institutional participation from hedge funds, pension and retirement funds, insurance companies, and sovereign wealth funds. So far, silver has not enjoyed equal recognition from these large players — but this is likely to change as fund managers recognize silver’s relative value and simply wish to diversify their precious metals exposure.

Silver Demand Trends

The biggest silver end-use sectors are first, jewelry and silverware, followed by electrical and electronics, where the metal’s outstanding conductive properties are unparalleled. Both categories were tarnished by the global recession . . . but thanks to the economic recovery in the Asian economies and the tenacity of computer and consumer electronics demand everywhere, silver usage by these industries is beginning to pick up.

In addition, we anticipate growing price-inspired substitution of silver for gold by jewelry manufacturers seeking to remain competitive with costume jewelry and other consumer purchases.

For much of the past century, consumption of silver in photographic films and papers was, by far, the biggest end use of silver, at times accounting for 35 to 45 percent of annual industrial fabrication demand. Today, photographic use is less than 10 percent of the total market — and it is continuing to decline both in tonnage and as a share of the market due to the expansion of digital photography among consumers and, increasingly, professional photographers.

The really exciting news for silver, in addition to the strength of investment demand, is the advent of new industrial and commercial applications. Together, new applications may not amount to much this year or next . . . but within a few years the ounces will begin to add up and will make a meaningful bullish contribution to aggregate silver market supply/demand fundamentals.

Its outstanding qualities as an electrical conductor, its unique anti-microbial properties offering protection against infection and disease, its excellent reflectivity, make silver a 21st-century metal. Silver investors and analysts will be hearing more and more about solar energy, medical applications, antibacterial textiles, radio frequency identification devices, batteries, water purification, and culinary hygiene.

Very importantly, the quantities of silver used per solar cell, kitchen countertop, surgical appliance or bandage, fabric garment, RFID, plasma screen, and other emerging end-use products are infinitesimal — measured in microns or nano-units. But, in not too many years, this will add up to millions of ounces a year in silver consumption.

The fact that silver content per product is so small means that industrial demand for silver in these applications is highly price inelastic — so that even a doubling or tripling in the metal’s price will have little significant impact on consumption. What’s more, the rise in silver usage from these emerging industries should continue apace even if the Western economies remain lackluster — or worse — over the next five or ten years.

Spotlight on New Uses

The most immediately promising high-growth end use for silver is from the rapidly growing solar-energy industry where the metal is used both as a conductor in solar cells as well as a reflector in mirrors. The industry is on a high-growth trajectory thanks to government tax incentives, the imperative in some countries for energy independence, and a popular desire for alternative, clean energy.

Another new and already growing use on the cusp of rapid growth is radio frequency identification devices. Manufacturers, distributors, and retailers are beginning to use RFIDs in place of bar codes that require visual scanning. RFIDs can be scanned through shipping boxes, grocery bags, and even bulk containers. What’s more, RFIDs are already in significant use by a number of nations for personal identification in passports and other documents, including air and rail transportation tickets in China at a rate of billions per year.

Next, the medical sector is beginning to turn to silver for its remarkable anti-bacterial qualities. Surgical bandages, wound treatments, catheters, surgical and hospital garments, catheters and pacemakers are all new and important end users for what some may consider a miracle metal.

Similarly, its biocidal properties is leading to new use of silver in culinary products to promote food and kitchen hygiene with countertops and surfaces, cooking utensils and appliances, vending machines, and food packaging that contain tiny amounts of silver.

The textile and clothing industry — particularly sportswear, athletic clothing, and footware manufacturers, is also beginning to look to silver as an effective preventive of bacterial odors that thrive on sweat and body heat.

I mention these emerging new uses not because any will influence the silver price this year or next . . . but together they will take more and more ounces in the years to come with eventual implications for aggregate silver demand and future price prospects.

Price Prospects

By historical standards, the gold/silver price ratio suggests that silver is an undervalued precious metal. Today at 68, the ratio simply means it takes 68 ounces of silver to purchase one ounce of gold.

Some silver enthusiasts take comfort in the fact that over thousands of years the ratio held fairly steady around 15 or 16. Other’s point to the geological fact that the Earth’s crust, as best as scientists can measure, contains some 17 or 18 times more silver than gold.

Over the past decade the ratio has been as low as 45 in 2006 and as high as 82 in 2008. Recently, it has been near the middle of this range around 65.

To my way of thinking, the gold/silver ratio has little predictive value — except to the extent that expectations of a return to historical norm may be a self-fulfilling prophecy.

What counts most are the supply/demand fundamentals in each market and the intensity of investor interest in one metal relative to the other. Yes, investor interest in one metal versus the other may be influenced by the perception among some investors and speculators that the gold/silver ratio is above (or below) some historical mean — but that will go only so far and last only so long.

Ultimately, it is the relative market fundamentals that matter most — and I believe the fundamentals now favor silver. These fundamentals are (1) the recovery of worldwide jewelry and industrial fabrication demand, (2) the emergence of significant new uses in the years ahead, (3) the inelasticity of demand relative to price in some end-use industries, (4) the inelasticity of supply, given that at least 70 percent of silver mine output is a co-product or by-product of other metal mining, and (5) rising investor interest among both retail and institutional investors in the old industrial world and the newly industrialized Asian nations.

Based on silver’s own improving supply/demand fundamentals, I expect higher silver prices in the months and years ahead. Consistent with my forecast of $2000 gold in the next few years, I expect silver to hit and surpass its 1980 all-time peak around $50 an ounce. For those who want to know, this works out to a gold/silver ratio of 40 From an historical perspective this is certainly not an unrealistic relationship between the two precious metals.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

We should have seen it coming. On Thursday, when Americans were celebrating Thanksgiving, the potential multi-billion dollar debt default by a Dubai state-owned development conglomerate triggered fears of renewed global financial turmoil. Dubai had borrowed some $80 billion to finance infrastructure construction and real estate development aimed at transforming its economy to an international tourist destination and financial center – but the global business slump has put these projects in financial jeopardy and the emirate state can no longer make payments due its creditors.

Reacting to this news, world equity markets sold off sharply on Thursday, as did U.S. stock markets on their Friday opening . . . and the dollar rallied sharply as, once again, many investors and traders saw it as a safe haven, just as they did at the time of the Bear Sterns and Lehman crises. This rush into the U.S. currency and the decline in world stock markets triggered a swift correction in gold, a correction that was, in any event, overdue, given the speed and magnitude of the metal’s recent advance.

Through mid-week, before the Dubai debacle hit home, the yellow metal had risen about 16 percent since the beginning of November, with demand fuelled by expectations of further central bank reserve diversification, growing pessimism about the sickly U.S. dollar, and increasing fears among some market participants about inflation in the next year or two.

Gold’s swift ascent early last week to successive historic highs had gathered momentum as the dollar dropped through key technical levels against the euro, yen, and a widely followed basket of currencies . . . and on news of additional central bank buying. First came a report that India might buy more gold from the International Monetary Fund, following its purchase of 200 tons earlier this month. Later came news the IMF had recently sold 10 tons of gold to the Central Bank of Sri Lanka and Russia’s central bank purchase of 15.6 tons from domestic mine production.

Last week’s price action is an important reminder that even long-term bull markets do not go straight up. While the focus has been on central banks, hedge funds, and retail investors in the West supporting the rising gold market, we have been hearing reports that demand in India and other price-sensitive markets was softening at prices over $1,100 an ounce. Moreover, the technical picture was already looking worrisome with some indicators suggesting a sudden, swift sell-off of $50 to $100 might be in the cards. Perhaps the market’s “Thanksgiving Day” drop was the expected correction . . . or perhaps not.

Here are more details and other timely Talking Points:

• Even a much deeper price decline would not change our expectation that the yellow metal will be going much higher in the next few years. In the short run, there are eager buyers – central banks, sovereign wealth funds, and hedge funds – as well as a multitude of small-scale retail investors – all looking for attractive price points to buy gold.

• China is – and will be – a growing influence in the world of gold and on the metal’s future price. According to the China Gold Association, the country’s gold demand may be more than 450 tons this year, up from 395.6 tons in 2008 (a 54.4 ton increase), and output may climb to 310 tons, compared with 282 tons a year earlier (a 28 ton increase). Clearly Chinese demand is growing more quickly than domestic mine supply – and the central bank is probably continuing to buy from local production as well. The gap is filled by imports, leaving less gold available in the world market. With these trends expected to continue, China’s net position will be a continuing positive force for gold prices for years to come.

• Longer term, more sovereign debt problems are likely to be a plus for gold. Dubai is just one of several countries facing possible bankruptcy. Others include Greece, Spain, Hungary, and Latvia. The real problem is that country debt defaults threaten the balance sheets of the lending banks and a contraction in credit available to otherwise healthy businesses and institutions.

• The four pillars of gold-price strength remain in place: (1) inflation-fueling U.S. monetary and fiscal policies, (2) central bank reserve diversification with the official sector being a taker rather than a supplier of gold, (3) expanding retail and institutional investor participation, and (4) declining world gold-mine production.

• As we have said repeatedly over the past year, announcements of official gold purchases by one or another central bank are quite likely. The IMF still has some 190 tons to sell . . . and, it seems the only question is which central banks are at the head of the line. Additionally, some gold-producing countries – like China, Russia, Peru, Venezuela, the Philippines, Indonesia, etc. – could purchase domestic production. Each announcement will promote additional private-sector gold demand and add support to the continuing rise in the metal’s price.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

Gold’s latest breakdown below $1,100 an ounce seems like a big deal — worrying gold bulls, vindicating gold bears, and giving market analysts and financial journalists something to write about. But, in reality, gold has been fairly stable in recent weeks, trading in a range between $1,090 and $1,140. Few get excited when a $10 stock moves up or down 50 cents, but every wiggle in the yellow metal’s price seems to garner much attention.

Although gold remains vulnerable on the downside, we believe the long-term trend remains the investor’s friend. The next really big move — say in excess of 10 percent (or more than $100) from current price levels — is much more likely to be on the upside.

In the meantime, smaller moves up or down in the price of gold are really no more than noise, as gold traders and speculators react to the latest news or technical triggers, but mean little for gold’s long-term prospects.

So far, today (Monday), gold seems to be holding up well. The move below $1,100 has not yet generated another round of technically inspired speculative selling . . . and does not seem likely to do so. Instead, the metal has bounced off its lows near $1,090 and moved back above the $1,100 level. If it holds above this psychologically important round number for a few days, traders and speculators could quickly kick the metal higher.

Judging from Monday morning’s news accounts, two developments may explain this morning’s swift price decline:

First, German Chancellor Angela Merkel cast doubts over the weekend that the European Community was ready to provide financial aid sufficient to prevent a default on Greek sovereign debt. This led to a decline in the euro, Europe’s common currency, in early trading this morning and gold fell in tandem as the dollar appreciated.

Second, this past Friday, India’s central bank, the Reserve Bank of India, unexpectedly increased its key policy interest rates to restrain excessive economic growth and temper domestic inflation. Historically, India is the world’s largest gold-consuming market — and some believe any tightening of monetary policy will temper the country’s gold demand.

If these two developments were indeed responsible for today’s quick decline in the price of gold below $1,100 an ounce, we think the market has again got it wrong. One thing about financial markets — no matter how wrong they may be in the short run, in the long run, they are always right.

First, the U.S. dollar is appreciating not because the American economy is the picture of health nor because U.S. monetary and fiscal policies are instilling confidence in the long-term value of our currency. If this were the case, yes, gold prices ought to be heading down. But it is not!

Rather, it is the euro that is depreciating against the dollar because the European economic situation is even worse than ours and because the euro’s very survival is now being questioned. Indeed, the race between the greenback and the euro is a race to the bottom, not to the top. And, regardless of which one win’s the race to the bottom, gold will, before long, be moving up in both currencies.

Second, with regard to India’s monetary tightening, the Reserve Bank’s objective is to keep the economy growing at a good pace over the long term. A sustainable expansion in economic activity with rising household incomes and increasing prosperity will result in more demand for gold jewelry and investment across India.

Importantly, Indian gold demand is very price sensitive — but it is the local rupee price that matters to Indian consumers and investors, not the dollar price in the world market. With the country’s monetary and interest rate policies resulting in an appreciating rupee, the local gold price will be more attractive to India consumers and investors.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

Gold managed to end last week over the psychologically important $1,100 level, after briefly falling to an intraday low of $1,085 an ounce last Wednesday. This recovery reflects an apparent resolution of the Greek sovereign debt crisis, bringing with it a stronger European currency, a weaker U.S. dollar and a bounce in the dollar-denominated price of gold.

The unexplained sinking of a South Korean naval ship late last week gave gold an additional boost . . . and serves as a reminder that scared money still looks to gold for safety and security at times of heightened geopolitical uncertainty.

Physical Demand in Asia Limits the Downside

The appearance of strong physical demand with gold under $1,100 in the past week across virtually all of the key Asian gold markets — India, China, Hong Kong, Thailand, Singapore, and Indonesia — speaks volumes about the future price of gold in the months and years ahead.

First it suggests that downside risks are limited. If the European sovereign debt crisis again raises “safe haven” demand for the U.S. dollar at gold’s expense, price-sensitive Asian gold buying will likely again provide strong support as it did this past week.

Second, it serves as a reminder of the region’s growing importance in the world of gold. Although different in many respects (economically, politically, culturally) they all share an historical affinity and allegiance to gold as an adornment, as a symbol of wealth and good fortune, and as a preferred vehicle for saving and investment.

Longer term, as the region’s share of global income and wealth continues to grow, it will demand a growing share of global gold supply — both annually and in terms of accumulated bullion ownership by the private sectors in these countries as well as by their central banks. We believe that demand across the region will be sufficient to push gold prices to new all-time highs over $2,000 an ounce and, quite possibly, over $3,000 in the next several years.

Not surprisingly, China and India, the world’s two most populous nations, are also the two biggest gold-consuming and investing countries.

India is an extremely price-sensitive market. Gold demand (as measured by bullion imports) falls rapidly when buyers “feel” prices are too high . . . and demand rises when buyers “sense” prices are too low. So it is notable that Indian demand has picked up sharply this year — and even more so in the past week. This pick up indicates that recent price levels, which a year ago not only scared buyers away but evoked selling and a rise in scrap supplies, are now perceived by Indians as attractive.

China, too, has seen increased buying this past week from jewelry manufacturers and investors. We have said over and over again that prospective growth in China’s appetite for gold is a key factor in our very bullish long-term view on the price of gold. Now comes the World Gold Council (WGC) in the past week with a report echoing our long-standing views and confirming the untapped growth potential of China’s gold market. According to the WGC, China’s investment and jewelry demand totaled 423 tons (over 13 million ounces) last year — and is likely to double over the next ten years. We think these estimates and projections are conservative and put last year’s demand at 450 tons or more with a doubling of the market expected a few years earlier.

To the Asian gold buyer, it is the local currency price that matters, not the price of gold denominated in U.S. dollars. Expected appreciation in China’s yuan, India’s rupee, and the currencies of some of the other Asian gold-buying nations will slow the rise in the local-currency denominated prices to consumers and investors in the region — and this shift in exchange rates, along with the regions strong economic growth, will be an important factor supporting strong growth in Asian gold demand over the years ahead.

Euro Fears Could Still Harm Gold — But Not For Long

Looking to the immediate future, the euro, the dollar, and by extension, the U.S. dollar denominated gold price all remain hostage to Europe’s ongoing sovereign debt crisis.

The announced Greek rescue package is sufficiently vague that its success over time remains questionable. Moreover, the attention of the currency and financial markets could shift focus from Greece to one or another EU nation with excessive sovereign debt.

Before too long, gold will be able to move higher regardless of the ups and downs in the euro/dollar exchange rate. The dollar-gold relationship is already weakening as world financial markets come to realize that the United States has its own sovereign debt crisis.

Lackluster demand for U.S. Treasury securities over the past month is the first sign that investors — central banks as well as institutional investors who typically buy America’s public debt and finance our twin trade and federal budget deficits — are becoming concerned that the risks associated with the dollar will erode the value of these investments over time.

The recent increase in yields on medium- and long-term U.S. government debt is indicating rising investor concerns about America’s sovereign debt. And it is these concerns that will drive the gold price higher — even if the dollar’s relative strength versus the euro remains firm.

We agree with former Federal Reserve Chairman Alan Greenspan who recently said that the rise in Treasury yields represents a “canary in the mine” that may signal further gains in U.S. interest rates as investors demand a higher risk and inflation premiums to hold U.S. Treasury and other public and private U.S. debt. Greenspan said higher yields reflect investor concerns over the “huge overhang of federal debt which we have never seen before.”

Just like the 1970’s we have the perfect recipe for stagflation. These trends will increase the U.S. Treasury’s interest costs and worsen our federal government deficit. They will also spill over into the mortgage market and slow the recovery in America’s housing and construction sector. It will also raise the cost of corporate debt retarding capital expansion by the private sector. The result will be more pressure on the Federal Reserve to monetize Treasury debt (print more money) in the hopes of staving off or postponing the rise in interest rates . . . and the result will be rising inflation even in the absence of a robust economy.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

From its recent low under $1090 an ounce on March 24th, gold has recovered some of its lost ground, trading above $1120 in early April. From a somewhat longer perspective, this is a gain of roughly 30 percent from its price of $870 exactly 12 months earlier — but the metal still remains well below its all-time high of $1227 reached in early December.

The question now is “Where Next?” The answer will be determined by a number of prospective developments:

FIRST — The Euro: Will the European currency regain its lost favor . . . or will sovereign risk considerations push the euro still lower against the U.S. dollar?

In the recent past, capital flight and currency speculation gave the dollar a boost . . . and the “appearance” of a stronger dollar has been gold’s chief nemesis ever since Europe’s sovereign risk crisis moved to center stage.

The announcement of a “bail-out” plan for Greece in late March eased sovereign-risk fears and gave gold some room to recover some of its lost ground from December’s historic all-time high.

But Europe’s currency crisis is far from over. Credit default markets are again signaling rising anxiety, not only over Greek debt but also over the sovereign debt of Portugal, Spain and Italy. In the near term, another run on the euro could again send gold lower, possibly even below the psychologically important $1100 level.

SECOND — U.S. Federal Debt: Rising anxiety over America’s huge Federal debt (as evidenced by the mixed reception by foreign central banks and institutional investors to U.S. Treasury debt offerings in the past couple of months) is undermining faith in the U.S. dollar and calling into question its future purchasing power.

As concerns about the dollar mount, as central banks and foreign investors demand a rising risk premium on U.S. Treasury debt offerings, the effect of Europe’s sovereign debt crisis and uncertainty about the future viability of the continent’s common currency will have a diminishing effect on the dollar — and gold will be free to reflect its inherent value.

THIRD — Eastern Demand: Will strong physical demand from China, India, and other important Asian gold markets continue to underpin the price, set an effective floor beneath the market, and limit downside risks?

Physical demand from this region, particularly India and the Middle East, tends to be extremely price sensitive. Now it appears that price levels around $1090, which in the past would have choked off demand, are now viewed favorably and attract buying from both jewelers and investors. Now, however, the reverse is true: In recent weeks, particularly as gold dipped toward $1090 an ounce, increased buying from the region (China, India, Thailand, Vietnam, Indonesia, Hong Kong, Singapore, and the Arabian Gulf states), provided strong support and helped push the price back above $1100.

I have no doubt that over the long term, significant and substantial growth in gold demand from this region will have a very positive, ultimately overwhelming, affect on the dollar price of gold. Strong economic growth, huge populations in China and India, and the rise in personal incomes and wealth virtually guarantee an enormous expansion in the quantity of bullion consumed in these countries for jewelry, industrial applications, and investment.

We have repeatedly expressed this view over the past couple of years — and now, it seems, others (including the World Gold Council) are joining the chorus of believers, so much so that some Western investors are buying gold in anticipation of stronger demand from the East.

FOURTH — Western Investment: Will the recent pick up in Western investment demand continue?

Investors are returning to gold exchange-traded funds (ETFs) after several months of lackluster interest. Bullion held on behalf of the 12 gold ETFs we monitor, rose by 929,373 ounces in March, recording the first monthly gain since last November. In contrast, gold ETFs saw net sales of 825,501 ounces in the first two months of this year.

At the beginning of April total global ETF holdings were 57.75 million ounces — just under their all-time high of 57.28 million ounces.

In addition, we hear that demand for gold bullion coins has also picked up in recent weeks, indicating that interest in gold from individual “retail” investors is also perking up.

While the question “Where next?” remains difficult to answer, we believe that gold will before long be moving higher, again reaching it’s all-time high of $1227 by midyear . . . and scaling new heights during the second half of 2010.

And, as the above developments coalesce positively for gold, we are still confident in our forecast of $1500 gold by the year-end 2010, with gold reaching $2000 an ounce and possibly $3000 an ounce over the next few years.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director, American Precious Metals Advisors

Central banks collectively have taken a much more positive view of gold in recent years. Increasingly, many investors – both retail and institutional – are looking at these official-sector gold purchases and concluding they, too, should be diversifying their savings and investments with some physical gold.

Just this week, it has come to light that Mexico’s central bank, the Banco de Mexico, purchased some 93.3 tons this past February and March. That’s about 3.5 percent of annual world gold-mine output worth more than $4 billion at recently prevailing prices.

After net sales of roughly 400 to 500 tons a year over the prior decade, the official sector (including central banks, the International Monetary Fund, and sovereign wealth funds) became a net buyer of gold in 2009.

Last year, net official purchases continued as a number of central banks, principally in Asia, added to their official reserves while sales by European central banks were minimal – and have now virtually ceased except for some small reductions for domestic gold coin programs.

Net official purchases may have totaled as much as 100 to 200 tons in each of the past two years, even allowing for the IMF’s 403 ton gold sales program, which ended some months ago.

Officially published data on central-bank gold transactions are not to believed as some countries buy gold surreptitiously, choosing not to report purchases . . . and data on sovereign wealth fund gold investments are, for the most part, unreported. So, it’s not possible to get an exact reckoning of net annual purchases or sales by the official sector.

China, for example, announced just about two years ago that its central bank had purchased 454 tons in the prior six years – but chose not to report these purchases until April 2009. Some observers, myself included, believe that China continues to buy significant quantities on a regular basis, possibly 100 tons or more annually, some if not all from domestic mine production.

Saudi Arabia also added significant quantities of gold – 180 tons, in fact – to its official holdings over the past few years – but did not report these purchases until last June. It is likely that the Saudi Arabia Monetary Authority also continues to buy . . . along with some of the other oil producers with dollar-heavy, gold-underweighted official reserves.

The People’s Bank of China, the PBOC, and other central banks have an incentive to buy gold discretely and surreptitiously – simply because the announcement and acknowledgment of their buying programs would likely affect the yellow metal’s price and raise these central bank’s acquisition costs.

What we do know is that the list of countries that have bought gold since the beginning of 2009 continues to grow. China, Russia, India, Saudi Arabia, and now Mexico have been the biggest buyers. Other gold-buying countries include Kazakhstan, Sri Lanka, Mauritius, Venezuela, Bolivia, the Philippines, Thailand, and even Bangladesh.

Meanwhile, in recent days, it has been suggested by senior German officials that Portugal ought to sell some of its official gold holdings to ease its difficult debt problems. Should such a sale take place it is likely that a number of other central banks would quickly line up as potential buyers, with Germany’s Bundesbank and the European Central Bank at the front of the line.

Recent year gold sales by the IMF have demonstrated that large-scale official sales need not disrupt the market – and that central banks underweighted in gold are willing buyers when given the opportunity to make off-market purchases.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director of American Precious Metals Advisors

Gold rallied sharply on the first trading day of 2010 – in part, mirroring a weaker U.S. dollar . . . but also reflecting the reestablishment of long positions by some funds and speculators who, despite their bullish view of the market, sold metal in December to realize profits earned from the rising price trend over the course of last year.

Gold and Silver Price Expectations

I expect the yellow metal will hit $1,500 an ounce – or higher – during the New Year, a gain of more than 35 percent from its December 31^st close.

And looking further ahead, gold’s bull market will likely continue for another few years, carrying the metal to a cyclical peak of at least $2,000 and quite possibly much higher.

At the same time, silver could very well outperform gold, rising from $17 an ounce at the end of last year to an annual high of at least $25 sometime during 2010, a gain of more than 45 percent from last year’s close.

While silver’s advance will mostly reflect strong cyclical growth in both industrial and investment demand, gold will benefit not only from cyclical forces but also from a rising secular expansion of investor participation, central bank reserve diversification (which is only just beginning), and an irreversible erosion of the U.S. dollar as the single dominant reserve asset and denominator of much world trade.

As a result of these secular developments, over the next decade and beyond, the long-run average price of gold (stripping away the major cyclical bull and bear market swings) will be considerably higher than past experience would suggest . . . and considerably higher than many analysts and investors would dare imagine.

Buying Opportunities

In the meanwhile, both gold and silver will continue to stumble from time to time with continuing high price volatility. As in the past, changing expectations about U.S. interest rates and Federal Reserve monetary policy as well as other international developments that may benefit the dollar exchange rate will trigger reversals in the prices of these metals.

Economic statistics indicating a more durable recovery or accelerating price inflation at times may lead some to believe the Fed will begin tightening policy sooner than later – and this could briefly push the dollar higher and gold lower.

Indeed, tough talk by the Fed or hints of an imminent increase in the Fed funds interest rate – and, even more so, the first step up in this key policy rate – will almost certainly trigger a dollar rally and selling of gold and silver. However, any tightening by the Fed will be too little, too late to reverse the eventual rise in U.S. inflation and depreciation of the U.S. dollar.

Similarly, fear of sovereign debt defaults by one or another European country (or elsewhere) could also benefit the dollar and temporarily hurt gold. But gold is the ultimate safe haven and the dollar, without the support of sound monetary and fiscal policies, is a depreciating asset, tarnished by an erosion in its real purchasing power, so those seeking safety in the greenback will do so at a heavy cost.

As in the past year, these occasional reversals will lead some to believe the party is over for precious metals – but I believe periods of weakness will be opportunities for those underweighted in gold and silver to augment their holdings of physical metal.

No Bubble Here

There continues to be much talk from gold’s detractors that the strong advance in the metal’s price over the past year is nothing more than a speculative bubble ready to burst . . . and, when it does, the price will come tumbling down. But, in my view, gold’s strength is built on solid fundamentals – fundamentals that gold bears, among them a number of eminent economists, fail to recognize.

Very briefly, these positive fundamentals for gold are:

U.S. monetary and fiscal policies will remain extremely expansionary and, ultimately, inflationary. With Federal debt now over $12 trillion and annual deficits projected at over $1.5 trillion for years to come, the Federal Reserve will be forced to buy more Treasury debt with newly printed money, eroding the dollar’s purchasing power at home and abroad.

Strong continuing central bank demand for gold as more countries strive to diversify their official reserve holdings.

Expanding investor interest with more individuals and institutions viewing gold as a legitimate asset class, portfolio diversifier, and insurance policy.

World gold-mine production will continue its long-term decline for at least another five years – or longer without the incentive of still higher gold prices.

Expanding and evolving geographic markets, particularly China, India, and elsewhere in Asia where incomes and wealth are rising means that more people with a traditional cultural interest in gold will be buying substantially more gold jewelry and physical gold investments than ever before.

Jeffrey Nichols, Senior Economic Advisor to Rosland Capital

Managing Director, American Precious Metals Advisors

A few weeks ago, when gold and silver were near $1470 and $32 an ounce, respectively, quite a few economists and financial journalists were quick to pronounce the death of the decade-long bull market in precious metals and the start of a newborn bear market. Only days earlier, gold had registered a new all-time high near $1577 and silver was merely pennies away from regaining its 1980 historic peak of $50 an ounce.

At Rosland Capital, we foresaw and expected the recent correction in precious metals prices – believing that gold and, even more so, silver had from a technical or chartist perspective simply risen too far, too fast.

Even as precious metals prices plumbed their recent depths, we said “gold’s key price drivers all remain supportive,” advising clients to expect a snap-back with new all-time highs in the months ahead with the long-term uptrend continuing for several more years.

See our May 25^th Rosland Capital Gold Commentary for a detailed review of gold’s bullish building blocks.

So just how high will gold prices go from here? I expect the yellow metal’s price will hit $1700 an ounce by the end of this year – that’s only ten percent above today’s price – and I wouldn’t be at all surprised to see it even higher.

Looking further out, I believe we are likely to see gold at $2000 an ounce next year, and possibly $3000 or even $5000 an ounce before the gold-price cycle moves into reverse in the middle or later years of this decade.

At the same time, gold prices are likely to remain volatile registering big short-term swings both up and down. Just as we saw in early May, sizable intermittent price declines may lead some to question the bull market’s staying power. I can only warn you not to get caught prematurely in a bear trap.

I recently discussed gold trends –and my price forecast – with Pimm Fox, host of “Taking Stock” on Bloomberg Television. Here’s the link to show.

One question Pimm Fox asked during the interview was “how much gold and in what form?” I advocate most investors, both individuals and institutionals, hold a “core” position of five-to-ten percent of their investible assets in physical gold. At times, some smart investors may wish to hold more gold for short-term appreciation or add silver to their precious metals portfolio in addition to their core long-term gold position.

By physical gold, I mean the real thing – not paper gold, derivatives, or mining shares: For most retail investors, bullion coins like South African Krugerrands, Canadian Maple Leafs, or American Eagles and, for most institutional investors, good-delivery bars that are either COMEX or London deliverable.

Be aware that there are additional risks associated with paper gold products and other gold derivatives – risks that can be avoided or mitigated by purchasing and taking delivery of the real thing.

It seems that the University of Texas Investment Management Company, which manages the second-largest endowment fund in the country after Harvard University, agrees, having recently taken delivery of 20.7 tons of solid gold, gold that it now stores in a bank vault deep in the bedrock of Manhattan.

And the University of Texas fund managers are not alone: Some other institutional investors have been in the news during the past year or two, not just for buying gold, but also for taking physical delivery rather than, for example, holding shares in a gold exchange-traded fund.

I am often asked about gold and silver mining shares. Selected mining shares may have a role in some investment programs – but mining shares are not physical gold and should not be included in your “core” investment.

Be warned: gold and silver mining shares carry significant additional risks, risks that are not associated with buying and holding the physical metal. And, the recent experience of mining shares has disappointed investors who thought they were buying a leveraged gold investment. So far this year, the popular indexes of gold and silver mining shares, for example, have actually lost about ten percent of their value . . . but real gold, physical gold, has appreciated by roughly ten percent over the same period.

Remember, holding investments the value of which are presumably related to the price of gold – including futures and options contracts; mutual, closed-end or exchange-traded funds; gold trusts and other paper products; or mining shares – all carry addition risks and are just not the same thing as owning the metal itself in a form that you can pick up and hold in your own two hands.