Economic outlook are supportive of higher gold prices

The gold price soared to a new all-time high, touching $1,722.90 per ounce Tuesday morning. The price of gold advanced on the back of the United States being stripped of its AAA rating by S&P. The debt downgrade led to worries over the longer-term sustainability of the U.S. dollar as a reserve currency, prompting a flight to gold. Helping to amplify the trepidation among investors were fresh worries over contagion in Europe as Italian and Spanish debt came under heavy selling pressure.

In a note to clients, the Goldman economist wrote that “Even our new forecast is subject to meaningful downside risk. We now see a one-in-three risk of renewed recession, mostly concentrated in the next 6-9 months. There are three specific issues that concern us.

First, a worsening of the European financial crisis, and a failure of European policymakers to respond adequately, could lead to a further tightening of financial conditions and credit availability, which would worsen the economic outlook globally. Second, our forecast assumes that the payroll tax cut—currently scheduled to expire at the end of 2011—is extended for another year, but if that failed to happen the fiscal drag in early 2012 would increase significantly. Third, increases in the US unemployment rate have historically had a tendency to feed on themselves, and this could happen again.”

While Hatzius did not specifically discuss the gold price, the implications of the firm’s revised economic outlook are supportive of higher gold prices. Although the firm did not suggest that a third round of quantitative easing is a certainty, it is clear that the odds of an eventual restart of the Fed’s quantitative easing campaign have increased substantially. Furthermore, Goldman’s forecast echoes recent predictions from a host of noted investors – including Marc Faber, Jim Rogers, Eric Sprott, and many others – that Chairman Bernanke and the Federal Reserve are prepared to fire up the printing presses for as long as necessary to combat the deflationary headwinds facing the U.S. economy. As long as deflation is enemy number one of central bankers, the gold price is likely to remain well supported.