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Fed pivot will take gold to new heights, but a crash to $1,100 is a 'possibility' - Axel Merk

Kitco News

(Kitco News) - Following the bull rally in 2011, gold corrected 40% from its highs in July, 2011, before bottoming at close to $1,000 an ounce in 2015.

Although a repeat of this price pattern this time is a "possibility" if the Federal Reserve continues to tighten its monetary policy stance, it is still "unlikely", said Axel Merk, President and CIO of Merk Investments.

"The gold investor does not believe that the Fed can [hike] for much longer," he explained. "This [tightening] is a convenient policy today, but [The Fed] will blink at some point."

He added that although the Fed has been trying to fight high inflation throughout the year, the price level is unlikely to come down in the short-term.

"We may well have a stagflationary period for an extended period," said Merk. "The problem with high inflation is that it doesn't just come down and stay there."

He added that "gold is a volatile investment," given its price history.

Merk spoke with David Lin, Anchor and Producer at Kitco News.

Fed Reaction

Merk said that the Fed's only tool to fight inflation is the "sledgehammer" of reducing demand through higher interest rates, but that they will be unable to maintain a tight policy position.

"The Fed really wants to see things break," he said. "They can rarely ever keep tight policy as long as they want to, because things will break that get their attention."

He pointed to the Bank of Canada's recent rate hike of 50bps, which was less than expected, signaling a potential pivot away from tightening. Merk suggested that the Fed may be considering a similar move.

"Something will happen that threatens the stability of the financial system," he said. "At that stage, [The Fed] will say they did too much [tightening]… and financial stability is the one and only mandate that they care about strongly."

Although financial stability is not an official Fed mandate, Merk said that it is an implicit one, since "the survival of the banking system" is at the "core" of the Fed's mission.

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Gold After the Pivot

After the Fed's pivot, gold and gold miners will benefit, as investors flock to gold as a safe asset and portfolio diversifier, according to Merk.

"Gold tends to react earlier than equities," he said. "Most equities bottom out late, whereas gold miners and gold level out much earlier, at the earliest signs of a pivot."

Gold is currently trading near $1,650, and its price has fallen almost 10 percent over the year.

Merk said that although gold has been "correlated" with other assets, like stocks and bonds, these correlations will break down.

"Gold historically has served as a diversifier, and it's [lately] had less of that role and been more correlated," he explained. "Those correlations, when they come together, break apart again. I think gold is going to resume its role as a portfolio diversifier."

To find out Merk's view on how geopolitical risk affects gold, watch the video above.

Follow David Lin on Twitter: @davidlin_TV

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