"Gold has enjoyed a long and enviable climb, rising some 380 percent from a cyclical low near $255 an ounce in April 2001 to an all-time high just over $1,225 early this month. Looking ahead to 2010, don't be surprised to see gold trade at $1,500 or higher sometime during the New Year. And that's not all: I've been telling clients that the yellow metal's price will continue its long-term upswing for at least a few more years, very likely reaching $2,000 an ounce and possibly higher.
Still, it will likely be a difficult climb to the top - with continued high volatility and sharp reversals along the way, causing some observers to wonder if the market has already topped out.
Over the last few weeks, gold's short-term peak to trough decline amounted to more than 12 percent. With this correction, some are already celebrating the end of gold's nine-year bull market run. But gold's naysayers are ignoring important fundamentals:
- U.S. monetary and fiscal policies remain extremely expansionary and, ultimately, inflationary;
- There's strong continuing central bank demand for gold as more countries try to limit their exposure to a depreciating dollar and diversify their official reserve holdings;
- Investment demand is growing, with more individuals and institutions viewing gold as a valuable asset class, portfolio diversifier, and insurance policy, and;
- World gold mine production will continue to decline for at least another five years.
The December decline in gold has been a mirror image of the U.S. dollar exchange rate - but it's wrong to conclude that the greenback is strengthening. Rather, the decline in the euro and some other key currencies has simply accelerated. With reflationary monetary policies, low interest rates, and expanding government debt in virtually all of the major industrial nations, paper money nearly everywhere - not just in the United States - faces an eventual loss of purchasing power.
It seems dubious that the dollar's real and enduring worth is benefitting from rising fears of sovereign defaults. In our view, the dollar's real worth - that is its purchasing power for goods and services - is mostly a function of U.S. monetary policy and the rate at which the Federal Reserve is creating new dollars.
Ironically, just when a growing number of foreign central banks (in China, India, Russia, and elsewhere) are worried about their U.S. dollar exposure, some private-sector investors and traders, worried about their exposure to shaky sovereign debt, are seeking a safe haven in the dollar.
The foreign exchange and gold markets will continue to react reflexively to any hint that the Fed will push interest rates higher sooner rather than later. What counts, though, are not changes in nominal interest rates - but changes in real "inflation-adjusted" interest rates. As long as the rise in U.S. inflation outpaces each incremental increase in nominal interest rates - so that real interest rates remain near zero or in negative territory - monetary policy will be too accommodative and impotent to stem the rising tide of inflation.
As this becomes apparent, gold will recover from future short-term announcement effects of Federal interest rate policy and each time resume its long-term upward ascent. Indeed, for some time to come, any news of Federal Reserve tightening and the likely reflexive decline in gold will offer buying opportunities for smart investors.