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Volatile Market Conditions Lend Support to Gold Prices

There’s a market theory that a positive beginning to the New Year is predictive of trading activity for the balance of the year. If that is indeed the case, gold could resume its bull market after a two year hiatus that culminated in a major sell-off – predominately by gold ETFs – in the last quarter of 2013.

So far so good. Market volatility has reached levels not seen since September 2011 with the DOW alone dropping 318 points or 2% last Friday, its worst performance since November 25, 2011.

After making an apparent double bottom in late December – and contrary to predictions from several high profile investment banks – gold has already breached most of their rosiest forecasts for 2014.

You can bet when gold climbs a few hundred dollars higher, all these banks will reverse 180 degrees and recommend to their clients that they climb on board to ride the next wave higher.

Last week saw incredible volatility in emerging markets with Argentina devaluing its long suffering peso which plummeted 15% for the week. The Turkish lira and Brazilian real were also hit as investors pulled out money from these markets, anticipating a contraction in economic activity.

Perhaps even more ominous were signs of a contraction in China’s factory output (which also reflects global economic conditions) and turmoil in that nation’s “shadow banking” system which lends money outside formal channels and is beyond the reach of regulators.

The system was estimated to be as large as $US4.8 trillion in 2012, more than half the country’s gross domestic product. China’s biggest bank, Industrial & Commercial Bank of China, may be party to a $500 million default on a flawed investment product that was marketed to unsuspecting Chinese investors. Any such default would cast a pall over the entire Chinese banking system and potentially trigger a move into gold by worried savers and investors.

At the Davos economic conference in Switzerland, Prime Minister Shinzo Abe of Japan told an audience that the increasing tensions between China and Japan were similar to the competition between Germany and Britain before World War I.

The statement alarmed markets given the fact Shinzo Abe is an avowed nationalist and the consequences associated with the two countries entering into a military conflict could spell disaster for the global economy.

China has angered its neighbours by declaring an air defense identification zone over a chain of islands in the East China Sea claimed by China and administered by Japan. Ships, planes and other military assets from the two nations regularly patrol the zone, along with those of the United States, which has a defense treaty with Japan. Among the possibilities for a “Black Swan” market impacting event, this would have to be at the top of the list.

Coming up on Tuesday and Wednesday is the Federal Open Markets Committee Meeting (FOMC) which will determine whether to scale back its bond purchasing program beyond the previously announced $10 billion per month. Given current market conditions, it would be a major surprise if they did.

Some important housing data is also due out this week. In addition, earnings will be reported by companies such as Apple, Facebook, Amazon and others which could sway markets in either direction. Whatever the outcome by week’s end, investors could be exposed to some real fireworks.

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