Gold: What It Will Take to Overcome $1000

In our articles and newsletters we regularly highlight gold’s solid fundamentals.

• World financial/economic crisis may have culminated and greatest risks have been averted but it is still very far from over
• US dollar continues in its multi-year downtrend
• World governments are committed to issue huge volume of government debt for many years to come
• Quantitative easing – debt monetization – are becoming a routine practice of the Fed
• President Obama’s plans for government spending are making Bush deficits seem like child’s play

The list goes on and on. Most of gold bugs’ economic projections made years ago have come true, but gold has been stuck at a seemingly impregnable level of $1000 for almost 18 months. Will this level be overcome and when?

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In our view, the current economic situation has three different outcomes:

1. Reflationary policies of the Fed and the government will return the economy to real growth of over 2.5%. The Fed will be able to pinpoint the exact moment of when monetary tightening will need to take place and carefully begin raising short term rates, sell government bonds and agencies’ notes. Perfect, precise and proactive monetary policy will ensure price stability and relieve the threat of escalation in inflation. In this scenario, a V-shaped recovery declared by the bulls will become reality. The stock market will soar and gold, after an initial attempt to rally, will likely fall below $700 per ounce.
2. In a huge deleveraging cycle, deflationary forces experienced by the banks, businesses and consumers will continue to prevail for the next several years. World economy will largely remain in a state of stagnation – Japanese style. Pockets of growth in the world will be insufficient to turn the rest of the world economy around. In this scenario, it is likely that gold will remain in a wide trading range - $700 to $1000. The stock market will fall below the current bear market low, targeting 400-500 on the S&P 500. Gold will grow in real terms (Gold against the S&P 500) but not in nominal terms. Profits will be good for existing low-cost gold producers but it will, nevertheless, be a tough environment for PM investors.
3. Central banks and governments will continue to inject borrowed money into the unhealthy and unproductive sectors of the economy. This will undoubtedly lead to an increased role of lobbyism and a diminished role of the private sector and market competition – the main forces of capitalism. The result is easily predictable: very low economic growth for an extended period of time. Rising government debt and falling tax receipts, the growing role of the government and increased regulation will make political pressure on the Fed inevitable and overwhelming. Debt monetization, a crucial but only a “temporary” measure, will become an overused practice. Consequences of such a monetary policy will be downward pressure on the US dollar, inevitable rise in inflation expectations and an upward pressure on long term yields with growing concerns for fiscal sustainability. With such an outcome of events, the stock market will remain at a depressed level, but the price of real assets – energy, food, metals – will rise. The main beneficiary will clearly be gold, which will begin a new phase of its bull market.

While all of the three scenarios are possible, in our view, the probability of the first is close to a likelihood of an economic miracle. In the near future, we see either the second or third scenario evolving (this is in general terms as it is never possible to predict an exact path of an economy).

In the context of elevated unemployment, the Administration and the US Congress (which is starting to eye the 2010 elections), cannot allow themselves to stop stimulating the economy, cut spending and significantly raise taxes. Any attempt by the Fed to begin exiting its monetary easing strategy will prompt a renewed recession. All the talk of “exit strategy” will end as quickly as the stock market rally, prompting another deflation scare. As VP Joe Biden candidly stated: “We have to go spend money to keep from going bankrupt”. That is why we believe that the third scenario is the most probable outcome for the US economy in the next few years.

The main question is when will inflationary expectations begin to rise causing a new stage of a gold bull market? The best answer we can give is as follows:

The lag between monetary expansion and price inflation in the United States is about 3.5 years. The Fed started bloating its balance sheet about a year ago. Therefore, price inflation could really begin showing its teeth toward 2012. However, inflation expectations are a different animal. In the context of a major concern for fiscal sustainability and a prolonged period of elevated money supply by the Fed, inflation expectations can explode much earlier. It is quite possible that this could happen as early as next year.

If gold matches the inflationary spike of the 1970s, then its prices should easily rise toward $2,000.

Comments

[Roger Knights:]

What'll it take? A bankrupt European banking system would do the trick.

Jul 20 07:23 AM

[ManAboutDallas:]

What'll it take? No more articles such as this one wondering "When?".

Jul 20 07:42 AM

[DONE_SONZ:]

What does it take to keep gold under $1000?That's what's going on.

Jul 20 07:45 AM

[The Economi...:]

The maginot line was overrun? Learn your history. It barely saw any action because Germany attacked through Belgium. They went around it.

Jul 20 09:16 AM

[Skeptik:]

Logic is solid,patience will be rewardet.

Jul 20 10:40 AM

[Mad Hedge F...:]

Nice job. I have been a huge bull on gold this year, piling investors into the yellow metal at the $800 level in early January. But after an exciting couple of months, it has tiresomely become dead money. This is a commodity that has absolutely everything going for it; the Great Depression II, threats of nuclear war with North Korea, riots in Iran and China, a government borrowing binge of Weimar proportions, and money supply growth that is through the roof. In fact the US is doing everything imaginable to debase its own currency. Unfortunately, all I see on my screen right now is an ugly smudge at $950 an ounce. So what gives? Someone has been leaning heavily on gold every time it approached the magic $1,000 level, and they have now created a quadruple top on the charts. Gold has become the metal that everyone loves, but nobody wants to buy. There have been rumors of European Central Bank selling of gold reserves, Russian selling to cope with a lower oil price, and traders simply playing the range for lack of anything else better to do. The global risk reduction that began with a vengeance a few weeks ago is certainly having an impact. If demand from the famed Indian wedding season doesn’t come through, things could get worse. Gold bugs should expect to suffer more short term pain in this great long term core holding.

Jul 20 10:54 AM

[GMiki1:]

What will it take? A little cooler weather maybe. :) Or not even that. Push has come to shove and they're pushing and shoving.

Jul 20 10:58 AM

[Graham and ...:]

All we need is time. Gold is "scheduled" (on my timetable), to average $1000 in 2010. Past forecasts of this sort ($500 in 2005, $600 in 2006, $700 in 2007, $800 in 2008), have worked out pretty well, not being more than 6 months or so off.

Jul 20 11:50 AM

[pslater:]

The credibility of every Central Bank in the world depends on the price of gold NOT going up substantially. I beleive the Central Banks are selling gold with a vengeance in an effort to prop up the entire global fiat currency system which is shaking. This will work until it doesn't and then the market will set the real price of gold - MUCH higher than it is now.

Jul 20 06:06 PM

[nmelendez:]

Just keep it low for another year please, :) <=====Gold Accumulator

Jul 20 06:56 PM

[jambo:]

" Reflationary policies of the Fed and the government will return the economy to real growth of over 2.5%. The Fed will be able to pinpoint the exact moment of when monetary tightening will need to take place and carefully begin raising short term rates, sell government bonds and agencies’ notes. Perfect, precise and proactive monetary policy will ensure price stability and relieve the threat of escalation in inflation. In this scenario, a V-shaped recovery declared by the bulls will become reality. The stock market will soar and gold, after an initial attempt to rally, will likely fall below $700 per ounce."
.......,,,,,,,,,,,,,,,...
I wonder how such a scenario could even be postulated, let alone be the first of three possible. Those undaunted few who have -with the aid of giant but unsustainable government market manipulation- pushed up the pricing beyond anything remotely grounded in fundamental business, will be hugely disenchanted when their messiah and his crew finally fall victim to the laws of gravity. Most wont be back for more of the same, not in a cycle so flat that even water wont run.
Sorry, but I fail to see the value in stating the impossible.
Longer and longer gold.

Jul 20 11:41 PM

[chux08:]

"Gold bugs should expect to suffer more short term pain in this great long term core holding."

Pain?? I was thinking & BOOKING PROFITS!! I'm no gold bug but I did manage to sell some at $950 for a nice profit earlier today. If you buy your gold like you buy your groceries and that's when the price is (going) down and sell into strength, when the price is rising, I (and others who've learned how to trade "the lowest risk investment on Earth" like I have) don't care what the price of gold is going or not going to do. PRICE DICTATES MY MOVES, so if it does go to $700 you can be sure I'll be there on the BUY, gladly scooping up the gold you lost your nerve and bailed on. But yet, if it goes to $1200 you can BET that ain't my first sell point either and that I've made money at EVERY $25 stop of the old gold train as well.
Ya....pain....I don't know how much more of this I'll be able to stand!!!!!!!! :-)

Jul 21 01:36 AM