The Scaling of Gold to New Heights

New York Hard Assets Investment Conference 2011 Online Preview

Gold began the new millennium under $300 an ounce ... and under a cloud of pessimism among even many of its most ardent advocates. Today, some 11 years later, gold is setting new record highs above $1,500 an ounce - and, by my reckoning, the yellow metal has far to go before reaching its next cyclical peak.

In fact, I expect the price will very likely rise another $200 an ounce this year - or even more - reaching the $1,700 level by year-end 2011. This would be a "modest" gain of "only" 19% from last year's closing price and just about 13% above recent levels.

I'm no gold bug, but longer term, I believe gold will surpass $2,000 an ounce in 2012 as it continues its upward march to even greater heights - $3,000, $4,000, or even $5,000 an ounce - in years to come.

Today, despite record high prices, physical demand in key world gold markets - from the United States and Europe to China and India - has remained remarkably firm despite the record price levels prevailing in recent weeks.

In the past few years, each time gold prices reached big round numbers - $900, $1,000, $1,100, $1,200, $1,300 and $1,400 an ounce - buying interest abated for a while. But now, even with prices at all-time highs around $1,500 an ounce, physical demand remains firm, suggesting that many gold investors believe that higher prices are ahead.

In brief, here are some of the main reasons why I'm looking for much higher prices yet to come:

Number One: Inflation-producing US monetary policies by the Federal Reserve, irrational US fiscal policies and little progress reversing growth in US federal debt, a depreciating dollar overseas, and rising consumer price inflation at home. Despite all the rhetoric from both political parties, Americans simply are not yet willing to take the tough steps necessary to rein in the federal budget and shrink the country's immense federal debt.

Number Two: No quick or easy solution to the euro-zone sovereign risk crisis, a widening economic schism across the continent, and possibly the demise of Europe's common currency, the euro, as it exists today.

The growing disparity between the stronger "core" economies (led by Germany and the Netherlands) and the weaker "peripheral" economies (including Greece, Portugal, Ireland and even Spain) will lead to periodic funding crises such as we have seen from time to time in the past few years - and capital flight from the euro and the weaker European banks will continue to find a safe haven in gold.

Number Three: Political turmoil in North Africa and the Middle East is prompting some increase in world gold demand. As war ravages Libya without much chance of quick or orderly regime change, popular protests are now raging in Syria, Bahrain and Yemen, and no one knows where it may stop and what the long-term consequences may be for regional stability and future oil production.

Oil prices have already moved higher and motorists around the world are paying significantly more at the pump for gas. Many oil economists expect the uptrend in oil and gasoline prices to continue, not just for the next few months, but possibly for years - and this will certainly aggravate global inflation - and prompt more investment demand for the yellow metal.

Number Four: China's already huge and growing appetite for gold - both jewelry and investment - will continue in tandem with economic growth, rising personal incomes, worrisome inflation expectations and pro-gold government policies.

Much of the growth in China's gold demand over the past few years has been a result of the government's liberalization of the domestic gold market, its encouragement of private gold investment, and the development of new investment vehicles and channels of distribution.

While news of monetary tightening by the People's Bank of China may occasionally trigger brief gold-price reversals, China's growing gold demand is likely to have a powerful influence on the future price of gold for years to come.

Number Five: Rising long-term gold demand from India and other traditional Asian gold markets reflecting (as in China) growth in personal incomes and wealth, worrisome inflation, and the development of new gold investment vehicles and distribution channels.

In the past, high gold prices have often restrained Indian gold demand and triggered profit taking - and, at times, India's resistance to higher prices has weighed heavily on the world price. But now, even at recently prevailing prices near $1,500 and higher, Indians remain eager to continue buying - suggesting a psychological re-evaluation of gold's future price prospects.

Number Six: Increasing central-bank interest in gold will continue to underpin the price - as countries (such as China, Russia, and some of the OPEC nations) over-weighted in US dollar reserves seek the diversification offered by gold. Though much central bank and sovereign wealth fund buying remains off the books and unreported, I have no doubt that large-scale purchases are continuing to underpin the gold price.

Number Seven: A growing recognition and appreciation of gold as a legitimate investment class is prompting greater participation from both retail and institutional investors in the United States and Europe. At the same time, the development of new products and channels of distribution in recent years - especially the growing popularity of gold exchange-traded funds - continues to make gold more convenient, more attractive, and more accessible to more investors around the world.

Number Eight: At best, only marginal growth in world gold-mine production for at least the next five years - and the big gold-mining nations, like China and Russia, increasingly absorbing more of their own production for domestic jewelry consumption, investment, and additions to central bank reserves. As a result, expect a growing gap between new mine supply, on the one hand, and aggregate demand for jewelry, investment, and official buying - a gap that can be closed only by higher prices.

Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years. This originally appeared in his blog. His keynote at the New York Hard Assets Investment Conference on "The Bullish Case for Gold" will be on Monday, May 9.

About the Author
Jeffrey Nichols

Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.

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