INTERVIEW: Inflation Should Not Be A Problem For U.S., Canada, Gold Prices To Rise – Dundee's Murenbeeld

New York - (Kitco News) - Gold should reach an average price of $1,675 an ounce by the end of 2012, inflation should not be a problem for the U.S. and Canada, but will be persistent in China, according to a leading Canadian economist.

Martin Murenbeeld, chief economist for DundeeWealth Economics, said his firm sees an average price of gold at $1,515 in 2011, rising to the $1,675 level by the end of 2012. Dundee's projections are based on a model that uses different scenarios. In one scenario, he said, Dundee examines all the forces that will be negative to gold.

"We take all the bad assumptions, exit strategies, everything that we think pushes the price of gold lower," he said during an interview with Kitco News on the sidelines of the 2011 Hard Assets Conference in New York this week.

Then, Murenbeeld said, the firm examines a bullish scenario in which everything goes right for gold. Probabilities are applied to that scenario and a baseline established. "When we add all that up, we come to a number of about $1,515 for the year. That average will rise next year. The average is likely to be around $1,675 on present calculations."

Silver is a much more difficult metal to stick in an economic model, according to Murenbeeld, emphasizing that DundeeWealth has in past years tried to develop a process similar to what they use for gold. He said the problem is that a large component of silver is purely industrial with not so much monetary demand.

"At the margins there is some monetary demand and that is what has been exploding in the past few years," he said.

As a result, Murenbeeld said, "we don't have a good feeling about where the price of silver would go. "

He said, essentially, silver is a very high beta gold. "You literally have to have a steel stomach to be heavily invested in silver," Murenbeeld said.

Murenbeeld isn't worried about inflation in the U.S. and Canada but signalled China is the country in the limelight. In the U.S., he said, there has not been strong enough growth in the M1 and M2 monetary aggregates to cause inflation concern. The monetary base, he said, has burgeoned but "with the express purpose" of trying to push M1 and M2 higher.

M1 is the category of the money supply that includes all physical money such as coins and currency; it also includes demand deposits, which are checking accounts, and Negotiable Order of Withdrawal ( NOW ) Accounts. Economists use this measurement when they are trying to quantify the amount of money in circulation. The M1 is a very liquid measure of the money supply, as it contains cash and assets that can quickly be converted to currency.

M2 includes M1 in addition to all time-related deposits, savings deposits, and non-institutional money-market funds. M2 is a broader classification of money than M1. Economists use this category when looking to quantify the amount of money in circulation and trying to explain different economic monetary conditions.

One problem, however, is that the multiplier between the monetary base and M1 and M2 has collapsed and economists keep tabs on that relationship. Murenbeeld said there are varied reasons for the collapse, such as banks being unwilling to lend and consumers not having the willingness to borrow.

He said when the U.S. Federal Reserve buys bonds it puts the money into the banking system, and banks would normally lend it out. During this economic recession, however, they have put the money back into excess reserves.

"So you get a blow-up in the monetary base but you get no corresponding blow-up in the M1 and M2," he said, emphasizing that it is the worst thing that could happen. Famed University of Chicago economist Milton Friedman made famous the concept that money supply can't be allowed to collapse, Murenbeeld said.

"You can't allow M1 or M2 to turn negative for any period of time because you are flirting with depression," he said.

Murenbeeld said he agrees with what Fed Chairman Ben Bernanke is doing with U.S. monetary policy, which he said is quite different from what China is doing.

"China has massive growth in M1 and M2, much higher than what the economy would normally absorb, which I am inclined to believe is higher than stated," Murenbeeld said. "But China has a serious inflation problem that is purely monetary driven. The U.S. does not have that kind of problem. It may at some point but it doesn't have it now."

Murenbeeld is bullish on both equities and gold, which seems at odds since they can represent two different investing view points, but he doesn't believe it's an unusual stance. The situation depends on liquidity, he said. If there is enough liquidity in the system-money supply that is either being printed or otherwise being generated by central banks, "then the liquidity goes to seek a home and one of the homes would be equity markets."

For example, he said, when the Fed buys Treasury bonds, it pushes the bond price up and yield down. That causes investors to go to other assets---some to equities and some to gold, he said.

Despite the current pullbacks in commodities, Murenbeeld said he thinks a base will eventually be built. He said last week's pullback was interesting in that explanations of it ranged from bin Laden's death to the end of the second round of quantitative easing, to margin increases in silver. His preferred explanation is the margin rise. Silver had gone parabolic and the higher margins had to be put into effect to protect the system. "That was the kind of correction, in my point of view, that was waiting to happen," he said.

We'll go up again, and at some point, we will have another correction," Murenbeeld said, "because there are some fundamental things that will bias investors towards gold."

Some professional money managers are starting to treat commodities as a tradable asset class, which bothers some traditional investors as each commodity has different supply and demand fundamentals. Murenbeeld said to look at commodities this way, one has to start with the hypothesis that supply is relatively elastic.

"If I wanted to buy gold for my portfolio and store it somewhere, then I am directly affecting the price of gold because there is no increase in supply to meet my demand," he said. "In that case if enough investors come in at the same time to hold commodities, then presumably the price will rise if supply can`' meet that. And to some degree that has been happening."

But he said that may not be the whole story. DundeeWealth, he said, runs a model on oil and it showed that during the recent unrest in the Middle East and North Africa there was probably about a $15 per barrel premium in the price.

"That might be what you call speculative investment," he said. But he said it is a different situation when one approaches asset class as a fundamental investment and add commodities to achieve a certain rate of return or Sharpe ratio.

Money managers can do that now, he said, because commodities have become securitized. "So I can access commodities through the paper market-and for a portfolio manager that is very important," he said. "That is what happened with real estate." He said real estate prices were not a part of a typical money manager's portfolio. "As it became securitized, you could slice and dice it, put it in your portfolio and have it serve its purpose," Murenbeeld said.

By Debbie Carlson of Kitco News ; Terry Wooten contributed to the story

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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