Gold and silver both surged some 4% yesterday from oversold levels

Gold and silver both surged some 4% yesterday from oversold levels as the dollar weakened and oil surged. We said some weeks ago that the recent sell off in precious metals was likely to end around election day and believe that this has indeed happened and that gold will resume its secular bull market in the coming weeks. Important elections often see markets reverse course and witness trend reversals and this is one of the most momentous election victories in US history.

Gold should rally again on the gradual realisation that 44th President, President Obama, will be confronted with a challenge akin to the monumental challenge facing Franklin D Roosevelt in November 1932, in the early days of the Great Depression.

Central bankers and politicians look set to try and inflate their way out of the recent deflationary spiral. It is worth noting that gold outperforms other asset classes not just in periods of inflation or stagflation. Gold also outperforms in deflationary depressions as it did in the 1930s when the dollar (which was backed by gold unlike today in our modern floating fiat currency monetary system) was sharply devalued overnight by Roosevelt from $22/oz to $35/oz. Thus overnight in January 1934, gold was revalued by 59%.

It is worth remembering that the Dow Jones fell by 90% during the period and property prices fell by more than 50%.

President Obama's election also has historical parallels with the mid 1970s and the election of Jimmy Carter in 1976. Back then America and much of the western world was confronted with deep stagflation. Nixon had ended the convertibility of gold into dollars and backing of dollars by gold in the international marketplace in 1971. Deepening stagflation saw gold surge from $35/oz to over $200/oz in 1974. Then gold fell sharply by some 50% - from $200/oz to $100/oz in 1976. This should put the recent fall in the gold price into perspective.

After Carter's election in 1976, gold resumed its bull market and surged from $100/oz in 1976 to over $850/oz in January 1980. Similar price increases may be seen in the gold market in the coming years and gold’s inflation adjusted high of some $2,400/oz looks a very comfortable price target.

With President Obama's promise of a new "New Deal", gold is set to again confound the critics and show itself as an essential component in a properly diversified portfolio. No matter who was elected President, in the medium to long term the dollar is likely to come under increasing pressure due to the US' deteriorating fiscal position and this should see gold remain in a bull market.

Ex Goldman Sachs CEO, Treasury Secretary Hank Paulson and the Republican leadership may have been glad to see the dollar rally and oil fall sharply in recent months and that is what came to pass (greatly aided by the credit and solvency crisis and gigantic deleveraging of the global financial system). However, with the elections over, these likely countertrends may be reversed and the primary trends of a fall in the value of the dollar and a rise in the value of gold are likely to reassert themselves in the coming months

President Bush and his administration spent money like drunken sailors and their guns and butter economic policies (more guns than butter) have left President Obama with a poisoned chalice.

Goldman Sachs predicts that next year the US Treasury will issue an incredible $US2 Trillion in debt, or twice last year's record total. These are figures are more akin to those of a Latin American banana republic.

The policies of enormous tax cuts for the already extremely wealthy and favouring the corporate and financial sector and Wall Street interests at the expense of Main Street and the majority of Americans has left Main Street America on its knees and the great hope is that President Obama can help alleviate the suffering of thousands of Americans who are now losing their jobs and/or their homes.

President Obama must be careful that his fiscal stimulus and efforts to reflate the rapidly deflating economy do not result in deepening inflation and stagflation. This would then necessitate a Paul Volker style Federal Reserve Chairman who would hawkishly increase interest rates in order to tame inflation and encourage Americans to forego consumption and rebuild a culture of prudent saving which will be necessary if America wishes to regain its economic health again.

Interestingly, the highly respected Volker (who is rightly increasingly seen as the best Federal Reserve Chairman in recent history as Greenspan and Bernanke's reputations become tarnished) is being considered as Treasury Secretary but is more likely to be one of Obama's 'wise men' who will advise him on economic matters.

Physical demand for bullion remains very robust. There may also be a realisation that gold bullion's intrinsic value is something to be sought after in a world of volatile paper assets where politicians and central bankers have adopted the "inflate or die" fiscal and monetary policy option.

After a brief hiatus of deflation we are likely to get a sharp bout of stagflation in the coming months which, if not tendered to carefully, could lead to a more serious hyperinflation. Investors and savers should be cognoscente of the big picture historical trends and prepare, invest and save accordingly.