Is Europe Warming Up Gold for Its Final Act?

On Tuesday, Greek Prime Minister George Papandreou surprised European leaders when he called for a referendum on the new aid package for Greece. Since then, the referendum has already been cancelled. It was the latest drop in the roller coaster ride that’s called Europe. Concerns continue to mount on how Europe to fix Greece, and after that Italy. Unfortunately, between all the headlines and rumors concerning Europe, nothing has really changed. Europe is in a world of hurt that will lead to either a total overhaul of the financial system, or more money printing. Considering gold futures hit a six-week high at $1,765 on Thursday, precious metal investors are preparing for the latter.

Currently, it appears that officials are content with a temporary solution that will extend the status quo. This will result in more bailouts and money printing. The EFSF, which was hailed as the solution to fix the sovereign debt crisis, still remains unfunded. German Chancellor Merkel says hardly any countries in the G20 have said they will participate in the EFSF. In addition to more interest rate cuts from the ECB, Europe will turn to money printing to fund their so-called solution because no one is willing to cough up the money. Even if the ECB does not print, it appears that the IMF is standing on call. Dow Jones reports, "World leaders may mandate the International Monetary Policy to print more of its special currency to help solve the Eurozone crisis, according to several people familiar with the matter. Asking the IMF to print more of its Special Drawing rights, essentially an IOU that countries can exchange for cash, is one of the ways the Group 20 industrialized and developing countries is considering supplementing European efforts to stem a debt crisis threatening to spark a global financial meltdown and another recession." In the absence of aggressive debt write-downs and restructuring for several countries, all roads lead to money printing.

Gold is viewed as a hedge against inflation, deflation, and any other monetary skeletons hiding in the economic closet. Although gold is off its all-time record nominal high of $1,924, the case for higher gold prices almost seems bullet proof. When the Federal Reserve first announced its QE1 program in late 2008, gold was near $800 per ounce. Since then gold has been pushed sharply higher by the Fed’s QE2, a record-low interest rate guarantee until at least mid-2013, and Operation Twist. The Bank of England has also launched QE programs of their own. When the Eurozone receives a major bailout from the printing presses, it is likely to send gold prices well north of $2,000, and that’s just a baseline scenario.

The better scenario from the global debt crisis for gold investors is a worldwide race to devalue currencies, all in the name of sparking growth. This is already playing out, as seen by the recent Japanese yen and Swiss franc intervention. Another QE program from the Fed would also add fuel to the fire. Considering the potential to have a world of fiat currencies devalue and lose confidence at a record pace, the upside potential in gold almost seems unlimited. However, even the bull run of gold will eventually come to an end. Jim Rogers explains, "Gold will move into a bubble eventually. All long-term bull markets in every asset wind up in a bubble." Although he predicts a coming bubble, it could be years away. "I fully expect a bubble. Not for a few years but all bubbles look the same. And I hope I'll be smart enough to recognize the bubble when it comes," he says. According to John Williams, economist and editor of Shadowstats.com, for gold to reach its previous real inflation adjusted high, it would have to climb to about $7,000. Mr. Williams measures inflation using the same formula from 1980, as opposed to the current Boskin Commision revised CPI formula. Given that gold is now available on a global scale, and countries such as China and India are buying up the metal, gold may even overshoot Mr. Williams' figure.

Although it may seem unlikely in the near future, gold investors still need to consider a worst-case scenario for gold. Such a scenario would include governments and central banks all over the world becoming responsible, which means painful spending cuts and wiping out debt. At the current pace, this appears to be unlikely any time soon. However, like Jim Rogers explained, gold will eventually end with a bubble. Investors should prepare accordingly.

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