GOLD PRICE NEWS - The gold price correction remains in force as the price of gold dropped $4.10 to $1,092.05 - just a day after falling back through the $1,100 per ounce level. Strength in the U.S. dollar has kept a lid on the gold price as well as most of the commodity complex over the past two months. Given the high correlation between the gold price and the U.S. dollar/euro currency cross, the 11-week 10.7% decline in Europe’s single currency has led to selling pressure on the price of gold.

Notwithstanding the recent price action, the outlook for gold prices remains robust given the persistent economic headwinds. Monetary policy is focused on extinguishing deflation and this fact presents a bullish macro-economic backdrop for the price of gold.

Yesterday’s housing data illustrated that, while the rate of decline in home prices has slowed, significant economic headwinds are still present. New home sales plunged 11.2% to an annual rate of 309,000 - below not just the 354,000 figure the market was expecting, but nearly 5% lower than the lowest estimate of 325,000 in a Bloomberg survey of 72 economists,. A particularly troubling sign from the report was the fact that the supply of homes at the present sales rate rose to 9.1 months, the largest figure since May of 2009. The diminishing sale of homes and rising supply have created significant deflationary forces that have severely pressured the economy since the housing bubble burst several years ago.

The weak housing figures were corroborated by this morning’s durable goods data, which fell 0.6% excluding transportation equipment. This was the largest decline in six months and demonstrates that capital spending remains tepid at America’s corporations. On Capitol Hill yesterday, Federal Reserve Chairman Bernanke painted a gloomy picture of the U.S. economy, focusing on stubborn high unemployment and a struggling housing market. He reiterated that the Fed Funds rate would remain low for an extended period of time and noted that inflationary pressures were likely to stay “subdued.”

There is a significant amount of misleading information about the drivers for the gold price, chief amongst them is that gold cannot rise in a deflationary environment. The core consumer price index declined in January for the first time in over two decades, yet the gold price is comfortably above $1,000 per ounce. As discussed many times in these pages, the gold price has benefitted from the deflation-fighting policy initiatives that have been implemented by central bankers and politicians across the globe over the past eighteen months.

Gold tends to perform well when confidence is declining, economic growth is stagnant, and central bankers and politicians are implementing policies designed to promote inflation. When confidence is high and economic growth is robust, as was the case in the 1990s, then the gold price tends to perform poorly. Constantly posed by skeptical investors is the question of how gold can rise in a “deflationary” environment. The answer is that a policy response designed to fight deflation causes inflation - and by definition debases the currency, a bullish macro-economic backdrop for gold. When inflation becomes the priority of central bankers, then one will have to seriously rethink long positions in the gold sector. That time is not now.