Where Next for Gold?


This nascent gold-price recovery reflects, most of all, an apparent resolution to Greece's sovereign debt. The question now is "Where Next?"

From its recent low under $1090 an ounce on March 24th, gold has recovered some lost ground, trading above $1120 and testing the $1130 level in early April. From a somewhat longer perspective, gold has risen roughly 30% from its price of $870 an ounce exactly 12 months earlier—but the metal still remains well below its all-time high of $1227 reached in early December 2009.

This nascent gold-price recovery reflects, most of all, an apparent resolution to Greece's sovereign debt, bringing with it a stronger European currency, a weaker U.S. dollar and a bounce in the dollar-denominated price of gold.

The question now is "Where Next?" The answer will be determined by a number of prospective developments:

FIRST—The Euro

Will the European currency regain its lost favor. . .or will sovereign-risk considerations again push the euro lower against the U.S. dollar?

In the recent past, capital flight and currency speculation gave the dollar a boost. . .and the "appearance" of a stronger dollar has been gold's chief nemesis ever since Europe's sovereign risk crisis moved to center stage.

The announcement of a "bail-out" plan for Greece in late March eased sovereign-risk fears and gave gold some room to recover some of its lost ground from December's historic all-time high.

Looking to the immediate future, the euro, the dollar, and by extension, the U.S. dollar denominated gold price all remain hostage to Europe's ongoing sovereign debt crisis.

The Greek rescue package is sufficiently vague that its success over time remains questionable. Moreover, the attention of the currency and financial markets could shift focus from Greece to one or another EU nation with excessive sovereign debt.

Indeed, credit default swap markets are again signaling rising anxiety, not only over Greek debt but also over the sovereign debt of Portugal, Spain and Italy. In the near term, another run on the euro could again send gold lower, possibly even below the psychologically important $1100 level.

But, before too long, gold will be able to move higher regardless of the ups and downs in the euro/dollar exchange rate. In fact, the dollar-gold relationship is already weakening as world financial markets begin to realize that the United States has its own sovereign debt crisis.

SECOND—U.S. Federal Debt

Rising anxiety over America's huge Federal debt (as evidenced by the mixed reception by foreign central banks and institutional investors to U.S. Treasury debt offerings in the past couple of months) is undermining faith in the U.S. dollar and calling into question its future purchasing power.

Lackluster demand for U.S. Treasury securities over the past month is the first sign that investors—central banks as well as institutional investors who typically buy America's public debt and finance our twin trade and federal budget deficits—are becoming concerned that the risks associated with the dollar will erode the value of these investments over time.

The recent increase in yields on medium- and long-term U.S. government debt is indicating rising investor concerns about America's sovereign debt. And it is these concerns that will drive the gold price higher—even if the dollar's relative strength versus the euro remains firm.

We agree with former Federal Reserve Chairman Alan Greenspan who recently said that the rise in Treasury yields represents a "canary in the mine" that may signal further gains in U.S. interest rates as investors demand a higher risk and inflation premiums to hold U.S. Treasury and other public and private U.S. debt. Greenspan said higher yields reflect investor concerns over the "huge overhang of federal debt which we have never seen before."

As concerns about the dollar mount, as central banks and foreign investors demand a rising risk premium on U.S. Treasury debt offerings, the effect of Europe's sovereign debt crisis and uncertainty about the future viability of the continent's common currency will have a diminishing effect on the dollar—and gold will be free to reflect its inherent value.

Just like the 1970's, we have the perfect recipe for stagflation.

These trends will increase the U.S. Treasury's interest costs and worsen our federal government deficit. They will also spill over into the markets for private-sector debt as well as state and municipal debt. We expect rising mortgage rates to slow the recovery in America's housing and construction sector while rising corporate rates will retard business capital investment.

At the same time, the Federal Reserve, hoping to stave off or postpone the rise in interest rates, will continue monetizing Treasury debt (printing more money). . .and the result will be rising inflation even in the absence of a robust economy.

THIRD—Eastern Demand

Will strong physical demand from China, India, and other important Asian gold markets continue to underpin the price, set an effective floor beneath the market, and limit downside risks?

Importantly, the appearance of price-sensitive Eastern demand suggests that downside risks are limited. If the European sovereign debt crisis again raises "safe haven" demand for the U.S. dollar at gold's expense, price-sensitive Asian gold buying will likely again provide strong support.

Recent strong gold demand from the East Asian and Middle Eastern region also serves as a reminder of the region's growing importance in the world of gold. Although different in many respects (economically, politically, culturally) many countries across Asia and the Mideast share an historical affinity and allegiance to gold as an adornment, as a symbol of wealth and good fortune, and as a preferred vehicle for saving and investment.

Longer term, as their share of global income and wealth continues to grow, these countries will demand a growing share of global gold supply—both annually and in terms of accumulated bullion ownership by the private sectors in these countries as well as by their central banks. We believe that demand across the region will be sufficient to push gold prices to new all-time highs over $2,000 an ounce and, quite possibly, over $3,000 in the next several years.

China and India, the world's two most populous nations, are also the two biggest gold-consuming and investing countries.

India is an extremely price-sensitive market. Gold demand (as measured by bullion imports) falls rapidly when buyers "feel" prices are too high. . .and demand rises when buyers "sense" prices are too low. So it is notable that Indian demand has picked up sharply this year—and even more so in the past few weeks. This pick up indicates that recent price levels, which a year ago not only scared buyers away but evoked selling and a rise in scrap supplies, are now perceived by Indians as attractive price levels at which to accumulate metal.

China, too, has seen increased buying in March and early April from jewelry manufacturers and investors. We have said over and over again that prospective growth in China's appetite for gold is a key factor in our very bullish long-term view on the price of gold.

Now comes the World Gold Council (WGC) with a report echoing our long-standing views and confirming the untapped growth potential of China's gold market. According to the WGC, China's investment and jewelry demand totaled 423 tons (over 13 million ounces) last year—and is likely to double over the next ten years. We think these estimates and projections are conservative and put last year's demand at 450 tons or more with a doubling of the market expected a few years earlier.

To the Asian gold buyer, it is the local currency price that matters, not the price of gold denominated in U.S. dollars. Expected appreciation in China's yuan, India's rupee, and the currencies of some of the other Asian gold-buying nations will slow the rise in the local-currency denominated prices to consumers and investors in the region—and this shift in exchange rates, along with the regions strong economic growth, will be an important factor supporting strong growth in Asian gold demand over the years ahead.

I have no doubt that over the long term, significant and substantial growth in gold demand from this region will have a very positive, ultimately overwhelming, affect on the dollar price of gold. Strong economic growth, huge populations in China and India, and the rise in personal incomes and wealth virtually guarantee an enormous expansion in the quantity of bullion consumed in these countries for jewelry, industrial applications, and investment.

FOURTH—Western Investment

Will the recent pick up in Western investment demand continue?

Investors are returning to gold exchange-traded funds (ETFs) after several months of lackluster interest. Bullion held on behalf of the 12 gold ETFs we monitor, rose by 929,373 ounces in March, recording the first monthly gain since last November. In contrast, gold ETFs saw net sales of 825,501 ounces in the first two months of this year.

At the beginning of April total global ETF holdings were 57.75 million ounces—just under their all-time high of 57.28 million ounces.

In addition, we hear that demand for gold bullion coins has also picked up in recent weeks, indicating that interest in gold from individual "retail" investors is also perking up.

So, Where Next?

While the question "Where next?" remains difficult to answer in the short run, we believe that gold will before long be moving higher, again reaching its all-time high of $1227 by midyear. . .and scaling new heights during the second half of 2010.

And, as the above developments coalesce positively for gold, we remain confident in our forecast of $1500 gold by the year-end 2010, with gold reaching $2000 an ounce and possibly $3000 an ounce over the next few years.


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