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Gold Bull Market Unstoppable with Economic Turmoil and Inflation on the Horizon

Commodities / Gold and Silver 2010 Jun 01, 2010 - 05:29 AM GMT

By: Money_Morning

Commodities

Best Financial Markets Analysis ArticleLarry D. Spears writes: The gold bull is unstoppable. Gold prices are up fourfold since 2001 and hit a new record high near $1,250 an ounce on May 14. But they're still nowhere close to finished.

In fact, another four-fold increase could be in the cards.


"It sounds like a gold bug's dream," Money Morning Contributing Editor, Martin O. Hutchinson said in a May 13 Reuters BreakingViews column. "But looking back to the last inflation-adjusted peak price in 1980, it's far from impossible that the gold price could soon go above $5,000."

A recent survey of more than 75 gold market experts by David Bradshaw, editor of the brokerage newsletter Real Money Perspectives, found that most see gold topping $1,500 an ounce in the not-too-distant future, with $2,000 not far behind.

Even a few who are cautiously pessimistic, like Goldman Sachs Group, Inc (NYSE: GS), which last month cut its 2011 gold price outlook, still foresee higher prices - Goldman's new estimate is $1,350 an ounce, down from $1,425.

It's easy to see why so many analysts anticipate higher prices. The European debt contagion that's being driven by Greece, Spain, Portugal, Ireland, and Italy - collectively referred to as the PIIGS - has weighed the euro and undermined confidence in the European banking system.

In fact, the euro - which has fallen below $1.25 - could be in danger of failing as a currency.

Investors are rushing into gold to hedge against the Eurozone's financial turmoil. And because that the euro is the reserve currency for many nations, its drop in value translates to a higher price for gold purchases made in euros. Both these catalysts will continue to bolster gold prices until the underlying issues are resolved.

However, several other factors also contribute to gold's price movements, and most appear biased to the upside for the near future…

Supply and Demand
The earth has a finite supply of gold, and the increasing difficulty involved with retrieving the yellow metal is making it steadily harder to keep up with demand - especially since some long-time production leaders are now exhausting their reserves. South Africa, for example, produced 74% of the world's new gold at the turn of the century, but that has now dropped to 19%.

Estimates put the world's existing stock of processed gold at 160,000 metric tons, with about 2,400 tons being added each year. That amounts to a growth rate of just 1.75%, well below the worldwide increase in demand (though recycling of "used" gold, which accounts for about 30% of new supply each year, helps offset some of the imbalance).

Cumulatively, recent demand has outstripped supply by more than 1% a year, and that rate is accelerating - in part due to the introduction of exchange-traded funds (ETFs) that back their shares with stores of physical gold. The three largest - SPDR Gold Trust (NYSE: GLD), iShares Gold Trust (NYSE: IAU) and ETFS Physical Swiss Gold Shares (NYSE: SGOL) - now hold nearly 1,400 tons of gold, or more than half of annual production.

That will not only provide a basis for future gold price increases, but also provide a foot to put the brakes on any corrections.

One other demand consideration is also worth noting. Because of the weak economy and tightened personal finances, individual consumer demand for physical gold - both as an investment and in jewelry - still lags levels of a decade ago. However, that's starting to change - the World Gold Council reported just last week (May 26) that consumer demand in India surged to 193.5 tons during the first quarter of 2010, up nearly 700% from the same period a year ago.

As consumer demand for gold rises - both for hedging and jewelry - it feeds on itself. With financial uncertainty topping the daily news, ways to deal with it move to the front in both investment planning and cocktail party chatter. Nearly every financial advisor is now suggesting investors put some of their assets - usually 5% to 20% ­ - into gold, which supports prices.

Inflation on the Horizon
As already noted, the euro has taken a beating recently - but it's not the only currency that's suffering. What's more, many analysts believe the ill-advised and poorly executed efforts by governments to "stimulate" the global economy out of recession will ultimately debase all of the world's paper currencies.

Just as an example, the United States is now $13 trillion in debt and, even with the artificially low rates still being mandated by the Federal Reserve, will have to pay $224 billion in interest this year - and even more in the future as spending and rates increase.

That situation is leading many economic pessimists - and nearly all gold bugs - to argue that the dollar will eventually be worthless, leaving gold as the only accepted form of exchange.

Turn the currency-devaluation issue around, and it becomes inflation - always a justification for higher gold prices.

"Based on (the rate of) consumer price inflation," said Money Morning's Hutchinson, "the peak of $875 an ounce for gold in 1980 is equivalent to about $2,300 today."

And, he adds, if you scale up gold's price to the rate of growth in economic output, which has increased six-fold since 1980, it could justifiably top out around $5,300 an ounce.

Central Banks Stock Up
Central banks - the monetary authorities for the world's nations - are the largest traders of gold, buying and selling as needed to support their currencies and fund global trade. For the past two decades, central banks have been net sellers of bullion - but that has reversed in the past year.

Since early 2009, banks from emerging nations have turned into net buyers of gold. India, for example, bought 200 tons of gold from the International Monetary Fund (IMF) late last year, boosting its holdings to 6% of its total foreign exchange reserves. India's gold holdings peaked in 1994 at 20% of its foreign exchange reserves.

Meanwhile, China has been a huge net buyer of gold over the past five years, reportedly increasing its bullion reserves from 600 tons to 1,054 tons, and it will have to continue building reserves if it hopes to encourage global acceptance of the yuan in international trade.

So, there are plenty of arguments underlying the overwhelmingly bullish outlook for gold in the near future. Given the current levels of global uncertainty - economic, political and otherwise - it would be foolish not to include some form of hedge in your portfolio.

And, gold remains the classic choice in filling that role.

Getting Your Hands on Gold
Other than the obvious method - physically buying gold bullion or coins - here are four ways you may want to consider as a means of adding some glitter to your holdings:

ProShares Ultra Gold ETF (NYSE: UGL), recent price $53.32 - With current assets of $180.1 million, UGL is considerably smaller than the ETFs mentioned earlier. But this fund takes a different approach. Rather than investing entirely in bullion, it uses leverage and invests in derivatives and other assets with the goal of doubling the return of physical gold, as measured by the London p.m. fixing price in U.S. dollars. As such, it's more speculative than other gold ETFs - but may also do better in the event of a correction in bullion prices.

Gabelli Global Gold, Natural Resources & Income Trust (AMEX: GGN), recent price $16.02 - Similar to an ETF, this closed-end mutual fund invests in gold and other natural resources stocks in markets around the world. It focuses on companies engaged in exploration, mining, fabrication, processing, distribution, and trading of gold, as well as financing and managing gold-related activities. For investors concerned with income, it also pays a dividend, though the current yield is just 0.90%.

Newmont Mining Corp. (NYSE: NEM), recent price $54.01 - For those who prefer to cut out the middle man and go straight to the source, Newmont is one of the world's oldest, largest and most profitable gold-mining companies, with an additional focus on copper. It has assets or operations in the United States, Australia, Peru, Indonesia, Ghana, Canada, New Zealand and Mexico. At the start of 2010, NEM had proven and probable gold reserves of approximately 91.8 million ounces. With trailing-12-month earnings per share of $3.36, the stock also pays a 40-cent dividend.

Aurizon Mines, Ltd. (AMEX: AZK), recent price, $4.81 - Another straight-to-the-source play, Aurizon is smaller and far more speculative than Newmont. The company, based in Vancouver, B.C., has mining operations in the Abitibi region of northern Quebec, and is engaged in exploration in other areas of Canada. The company beat production goals in 2009 and posted record revenues, cash flow and earnings ($9.9 million, or 20 cents per share), which it used to pay down debt. That means the bulk of any added revenue from higher gold prices should go straight to the bottom line after accounting for production expenses.

Source : http://moneymorning.com/2010/06/01/gold-prices-11/

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