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Obama Tax Cuts Will Push Investors Further to Gold

The full version of our analysis (with comments particularly valuable for Precious Metals Traders) is available to our Subscribers.


Starting January, American workers will start to see changes in their paychecks as the Social Security tax break that was signed into law last Friday takes effect. Workers normally allocate 6.2% of their wages to Social Security on the first $106,800. This will be reduced to 4.2%. The Social Security tax cut is just one part of the package that was passed. Additional measures include extending benefits for the long-term unemployed and passing a lower tax rate for inheritance above $10 million (from the proposed 45% to 35%).

The inability of Obama's administration to collect higher taxes will pose a long-term challenge to the American economy. The government seems incapable of understanding that printing more money while reducing tax collection is a recipe to default. This mistake will have repercussions in a lot of ways, possibly even precipitating another meltdown that is worse than 2008 crisis. Unilateral financial "incentives" to the American public can turn into disincentives on the longer term. The future generation will be encumbered by a debt burden that is growing exponentially every year.

Although mainstream news reports rosy statistics, this means nothing. In-depth research will reveal that on the state, county, and municipal level, the US is edging towards bankruptcy. Even some of the wealthiest jurisdictions in the nation are facing fiscal problems. Forget about journalistic oxymoron that is thought of up payroll employees. Who has ever heard of a "jobless recovery?"

California itself is battling against insolvency while the Federal Reserve was forced to buy Treasury Bills to enable the government to stay operational. It is still early to say but the United States might be edging towards a third world status with all the recent decisions that government has taken. Of course the above is an exaggeration - the US will not likely become a third world country anytime soon, but it might lose its economic superpower status. The more money is printed, the more commodities become an attractive alternative. This makes both the job market and the real estate industry weak since gold and silver are rising relative to the US dollar.

Obama has been criticized by the Republicans and some people in his own party. The problems go back a long way. Larry Summers, Obama's National Economic Council director, mainly acted as a Wall Street henchman and enshrined unregulated derivatives in the financial industry. The government is now forced to make concessions that only amount to status quo in many cases.

The American president is facing a lot of challenges in passing key provisions in healthcare and in foreign policy in the Middle East. The recent tax cuts for the wealthy are designed to preserve some of his initiatives. But with the tax base of the government being eroded, there is no doubt that commodities like gold and silver will have strong years ahead as people turn to the ultimate money.

Gold Prices Likely to Increase

The fall of the dollar, increasing debt crises, and the deterioration of the G7 nations are all part of a one faulty system. This will force even more investors to turn to gold and silver as their hedge against uncertainty. In a previous article, we projected that gold will reach $1,600 relatively soon. But with the recent tax cuts, it is highly likely that it will move above the $1,700 in 2011 while silver will likely move well above the $35 level.

Ben Bernanke has said that the $600 billion QE2 package might be expanded if necessary. That, in itself, is enough to push otherwise bearish investors to gold. In this regard, let's take a look at the long-term gold chart (courtesy of http://stockcharts.com).

$GOLD Index

The gold chart this week still remains pretty much unchanged from last week. There are some consolidations below the upper border of the rising trend channel. Unless this particular resistance level is surpassed, the rally will not move to the eventual target of $1,600.
At this time, it is likely for the upper border to stall any rally temporarily. The possibility that gold will decline by 5-6% still exists.

Expectations in the Commodity Market

It is generally expected that commodity market will continue its rally as the dollar weakens further. Investment funds, pension funds, and long-term investors are expected to pour more money into this asset class. Future gains might not be as sharp as the past. If they steeply rise in value, consumers might not be able to take it (given the "joblessness" of the recovery that we've mentioned earlier in this essay), which will later lead to lower demand.

Now, let's look at oil prices. For the rest of 2010, oil could stay in the $70-$90 range as OPEC leaders don't see any need to change it. Leading oil suppliers agree that it is a fair price (in our view, the only way to have a fair price is to have a free market with near-perfect competition that determines what the price is - whatever it will be, it will be fair). China is a key driver of future demand but the government intends to curb inflation and thus, consumer demand. The weaker US dollar can send prices to the higher end of the range temporarily. But lack of demand at a higher price will again drive prices down.

Meanwhile, gold's "crazy little brother" might outdo it this time. Both silver and gold are expected to reach new highs for the first half of next year because Western economies will face slow growth. Investors will turn to these metals to preserve their wealth at first and then simply because they saw these markets move up fast (final part of an upswing is almost entirely emotional). In addition, investment demand from exchange traded funds and central bank purchases will continue to support prices. Silver might outperform gold on a percentage basis during the final part of this rally.

Although commodities will continue to act as a proxy for the weaker US dollar, it is important to note that commodities should be supported by actual usage. Uninterrupted price run-ups will have consequences. 10 to 15 percent corrections will likely become commonplace.


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