Expect Gold to Reach $3,000

As the gold price continues its steady climb higher and the U.S. dollar remains immersed in a downtrend, it is worth considering the importance of these macro trends. The headlines with respect to the ongoing depreciation of the U.S. dollar relative to the gold price and other global currencies have been recurring for a number of years. However, in recent months the number of stories has increased as the dollar has made 52-week lows versus a number of currencies and as the gold price, measured in U.S. dollars, has climbed near all-time highs.

What does the weak dollar really mean to an investor? We often read about large, disturbing macro trends, yet rarely think about the micro implications. What does it matter if the budget deficit is $800 billion, or 6.5% of GDP, versus the current estimate of $1.6 trillion, or 13% of GDP? Admittedly, the ramifications over short intervals of time are difficult to discern. This is one of the ways that policymakers sell programs such as stimulus checks or “cash for clunkers.” These programs are all about political posturing and creating the appearance of forging a solution. And while they deliver some semblance of short-term relief to a recession-battered public, crudely put, they are analogous to abetting drug addiction. Give the addict a quick fix and he’s momentarily liberated from his torment and sickness. The real solution, withholding the drug, requires a more painful short-term outcome but gives the addict a chance at recovery and renewal.

The innate desire to want short-term fixes is heightened by the ease with which the fixes are offered. Faced with brief, two-year congressional election cycles, politicians govern in order to keep their jobs, rather than to promote the long-term good of the people, however politically unpopular. Hence it is nearly impossible for the hard, but correct policy route to be taken. With respect to the declining dollar, the correct route is for consumers to pay down their debt and bolster their assets through savings, but the price of this is short-term pain. Saving leads to lower retail sales, which leads to lower economic growth, which leads to higher short-term unemployment - the unavoidable consequence of taking the correct route to solve the public and private spending excesses of this decade. Instead, policymakers are providing more incentives to consume, such as the “cash for clunkers” program, which compounds the declining dollar problem by driving both consumers and the federal government deeper into debt, even if consumers do save a few bucks on a new car. The patient cannot be cured by the same ailment that made him sick in the first place. Easy money is not the cure for a disease contracted by easy money.

With consumers burdened with debt and unable to muster more spending, the federal government has stepped in to fill the void. Keynesian deficit spending is in full force. But just as the creditworthiness of an individual declines as his balance sheet deteriorates, the same is true of sovereign governments. Think of a nation’s currency as the barometer of that country’s fiscal health. The persistent dollar depreciation we are witnessing is a vote of no-confidence on both America’s current financial health, and the outlook for its balance sheet going forward.

This past week, World Bank President Robert Zoellick provoked controversy with his comments on the economic policies of the United States and the U.S. dollar. Zoellick stated that the U.S. dollar is at risk of losing its role as the global reserve currency as both the euro and Chinese renminbi achieve greater prominence in global markets. He questioned whether the United States would be able to resolve its debt problems without resorting to inflation.

The concern of Mr. Zoellick, shared by world leaders, is that in order to manage the debt load America is incurring through large and growing deficits, the Federal Reserve, in conjunction with the executive and legislative branches, must resort to inflating away its debt problems. By making dollars cheaper, it becomes easier to pay off future debts. This insidious, hidden tax on savers robs hard-working Americans.

Ernest Hemingway famously penned that, “the first panacea for a mismanaged nation is inflation of the currency; the second is war. Both bring a temporary prosperity; both bring a permanent ruin.”

Inflation is a decline in the value of money caused by an increase in the money supply. As the supply of paper money increases – without a commensurate increase in production – the excess demand manifested by a greater money supply causes the price of goods and services to rise. More currency chasing fewer goods will eventually lead to price inflation. If the money supply is growing faster than GDP then prices will necessarily move upward. Business decisions become more difficult to make without stable money, hence investment often declines. Inflation can distort the economy and can lead to hoarding out of concern that purchases must be made now because prices will be higher in the future.

The U.S. dollar has lost 89% of its purchasing power over the past 59 years. The $10,000 life insurance policy held by the World War II veteran on his return home represented a significant amount of money in the 1940s. Now, that policy would barely cover the cost of a burial plot and funeral for a war hero. But the material decline in purchasing power is in no way a given, and the precedent for stable prices has a longer history than the era of inflation we have endured for three generations. From 1800 to 1929, the value of the dollar was stable – there was essentially no change in consumer prices for 130 years. It is ironic that the beginning of the inflation tidal wave started shortly after the creation of the Federal Reserve Bank in 1913, an entity designed to preserve price stability.

The acceleration of money supply growth following the collapse of the technology boom - and the cheap money and liberal credit that sprang from it - created the housing bubble that is chiefly responsible for the magnitude of today’s frozen credit markets. A similar misallocation of resources is occurring now and, as always, there will be consequences. In spite of the deflationary headwinds emanating from excess capacity utilization and a low velocity of money, inflation is always and everywhere a monetary phenomenon, just as Milton Friedman penned many years ago. Public sector deficit spending combined with a Federal Reserve that has implemented quantitative easing, or money-printing, alongside an unprecedented loose monetary policy will accelerate the decline in the purchasing power of the dollar. Nearly $19 trillion in U.S. public funds were pledged to save the global financial system. While a great deal of this total will be undrawn or repaid, a significant amount will not be.

Formerly, under gold-based monetary systems, inflation occurred when governments melted down or mixed other metals into the coinage, thereby diluting the gold content. Goods and services would require a greater amount of coins as money was debased. Inflation is a form of currency debasement. But how can the individual investor protect herself against inflation? One solution is to exchange inflation-sensitive assets like cash and bonds for hard assets like gold and real estate. As inflation rises, the level of real interest rates decline. Consequently, the opportunity cost of holding a sterile asset that pays no rate of interest declines. Gold acts as a store of value in such an economic climate, and has the advantage of fungibility, portability and ease of conversion into cash that other hard assets like real estate lack. Those analysts and market commentators who talk of a bubble in gold simply ignore the fact that its inflation-adjusted 1980 high is nearly $2,300 per ounce, a number 120% higher than the current price of just under $990 per ounce.

In such an environment of currency instability, the gold price and gold mining equities tend to preserve wealth. Larry Summers, former Secretary of the Treasury and current Chief Economic Advisor to President Obama, and Robert Barsky wrote an academic paper in 1998 titled Gibson's Paradox and the Gold Standard. Their research led them to conclude that price action in the gold price is driven by the reciprocal of the real rate of return from the global capital markets. Demand for gold and, accordingly, the gold price are dependent on what alternative rate of return is available in other asset classes. A low-return environment in traditional asset classes such as equities and bonds will create increased demand for gold. The relatively small size of the gold bullion market and the gold equity market, combined with the magnitude of potential demand, creates a situation wherein explosive price gains are a possibility. Per Summers and Barsky's research, the recent investment climate characterized by tepid long-term returns in stocks and bonds, combined with the prospect of continued monetary inflation to combat the credit crisis, strengthens the case for increasing an investor’s exposure to the gold price and gold equities in spite of the risk associated with short-term oscillations.

Comments

[Vuke:]

Whatever price gold does reach will reflect the new economic reality beneath today's smoke and mirrors magic lantern show. In effect, it will buy then virtually the same goods and services as it does today but, likely, a lot more paper.

Its advantage lies in the fact it is almost guaranteed to do so whereas most everything else carries a risk of either collapse or excessive taxation. Gold just sits there, silent but pretty, watching the show unfold.

When its call comes, like Cinderella, it will rise for its performance to be recognized as the real star of the event.

Oct 01 12:12 PM

[Angel Martin:]

Don't see the rationale for the $3000 forecast. Comparisons to the gold price at the top of the bubble in 1980 is like pricing tech stocks compared to Feb 2000.

from the article:
"Demand for gold and, accordingly, the gold price are dependent on what alternative rate of return is available in other asset classes. A low-return environment in traditional asset classes such as equities and bonds will create increased demand for gold. "

This works in reverse as well, if the economy recovers, gold will get killed (ie. back to $250-$300 level consistent with CPI growth over the last 80 years).

Oct 01 12:23 PM

[SPOTS:]

Angel,
You said, " if the economy recovers, gold will get killed ".

But you miss the velocity point. If the economy recovers, all the trillions the Fed printed will see a much faster velocity. That will cause a rapid increase in inflation.

Oct 01 01:21 PM

[Bill Crow:]

¨Faced with brief, two-year congressional election cycles, politicians govern in order to keep their jobs, rather than to promote the long-term good of the people, however politically unpopular....INANANE

The article infers the two year cycle of elections (House of Representatives) causes the¨Congress¨ (House) to vote for expedient expenditures instead of long term ´GOOD OF THE PEOPLE¨ Is wrong. The problem is that Congress attempts,poorly and wrongly, to legislate economics! The founding fathers intended politicians to return home frequently, not live in Washington, to hold office for a limited time (TERM LIMITS NEEDED).

Senators (6 years) think their offices are life time jobs and use taxpayer money to dole out favors to be reelected, not to say anything about ACORN. Regardless of term lengths, the politicians pass fantastic pensions, pay raises, and other largess enriching themselves at our expense and PROMOTING THE WELFARE OF THEIR PARTIES!
Bill c

Oct 01 06:37 PM

[optionsgirl:]

Your guess of $3,000 is just that, a guess. We don't know where it will go. I only know that I never contemplated such high numbers before 2007, and now,a few years later, no number surprises me.

Yesterday I read that we could be in an era of peak gold, because the mature large gold mines are already 13,000 feet deep (S. Africa). Less production, higher costs and lots of junior miners not yet in production, coupled with high world wide demand add another element to the gold picture. Only time will tell.

Oct 02 09:16 AM

[swsprime:]

I liked the article Tim, and I will follow you now.

One question though, not that I'm anti female, far from it, but being a little sensitive to feminist gender attacks, I must ask why did you use the feminine pronoun as in:

'But how can the individual investor protect herself against inflation?'

You could have said 'himself' which is the usual form, or himself/herself' which is the bending over backwards P.C. form, or 'herself/himself' which is the double bending over backwards P.C. form, or 'themselves' which is grammatically clumsy, but bypasses the whole gender issue altogether, but no, you chose 'herself'.

Does that flag something about you? Are you female? a feminist female? a male feminist? a commy agent? a transvestite gold bug? or just grammatically lazy? I'm curious.

Oct 02 10:07 AM

[Graham and ...:]

$3,000 gold. Just like the Aden sisters predicted in 1982. But it will be some time after 2010, thirty years or so (two generations) later.

Every price at some time. But the French speculators who paid $50 million for the Mississippi Valley Co. in 1718 didn't see it get back to that level for another 100 years or so (President Thomas Jefferson paid only $15 million for the equivalent, Louisiana Purchase, in 1803).

Oct 02 11:09 AM

[T.Stamps:]

This administration doesn't believe in growth but lots of
debt. Yes, gold looks good.

Oct 02 11:19 AM

[no goldbug:]

two remarks to your statement "if economy recovers...." -> the problem is, that specially for the US economy this won't be possible without a complete monetary reform which devalues all depts because the actual amount of total dept (private+households) of 500 % of GDP is higher than the value Germany had after WW1 reparation. The FED is more and more forced to monetarize US dept.
"Gold back to 250-300 USD level..." -> never ever because this is just 50% of average variable costs. The total costs of gold mining are >800 USD, below this level mines won't work.


On Oct 01 12:23 PM Angel Martin wrote:

> Don't see the rationale for the $3000 forecast. Comparisons to the
> gold price at the top of the bubble in 1980 is like pricing tech
> stocks compared to Feb 2000.
>
> from the article:
> "Demand for gold and, accordingly, the gold price are dependent on
> what alternative rate of return is available in other asset classes.
> A low-return environment in traditional asset classes such as equities
> and bonds will create increased demand for gold. "
>
> This works in reverse as well, if the economy recovers, gold will
> get killed (ie. back to $250-$300 level consistent with CPI growth
> over the last 80 years).

Oct 02 02:15 PM

[The Recusant:]

We fool ourselves if we think that the current and even previous administrations have not considered the strong possibilities of inflation and the rise in the price of gold. And we can bet that they have a plan A, B, and C to resolve the immediate problems with each. How effective they will be is to be seen although past performance indicates that whatever plan they do follow will be for a near term span of time that correlates with their re-elections. However, they may have tricks that will keep gold from achieving its true dollar-ratio price in order to continue their manipulation of the commodity, the market, and the dollar. Our only action to counter their plans is to continue to push for gold as a standard for the U.S. dollar and to buy and promote its purchase as much as possible.

There is something terribly wrong in our country. End it...buy gold.

Oct 02 02:30 PM

[goldtheory:]

All the above comments are extremely interesting, but not promising as a sound strategy to buy gold as an investment asset. Below is the only sane rationale on how to get the most from your investment in metals.

What one simply has to do is buy 2000 lbs. of lead (atomic number 82) and build a fallout shelter in case of nuclear attack. Then, hunker down, and wait inside for the final moment. When it comes, the shelter will be irradiated by the bombs, and turned into gold (atomic number 79). Inside, you will be safe and sound since lead doesn't absorb radiation, but blocks it. You now will have 2000 lbs. of gold with nowhere to spend it. And, a way to turn lead into gold.

Oct 02 08:58 PM

[Plan B Econ...:]

Let's not forget that supply and demand for gold influence its price just as much as the value of the currency it is being priced in.

www.planbeconomics.com.../

Oct 02 10:04 PM

[Jake2:]

lol

Oct 03 01:31 AM

[HA65MPH:]

GOLD IS CHEAP NOW , AND BETTER GET IT WITH FIAT USD ...OR JUST SIT ON YOUR BUTT ! JMHO

Oct 03 01:49 AM

[Dr. O:]

>>From 1800 to 1929, the value of the dollar was stable – there was essentially no change in consumer prices for 130 years.<<

Hadn't thought about that. Makes sense. A "double eagle" gold coin with about an ounce of gold was worth $20 in the 1800s well into the 1900s. These coins circulated as the gold content was worth less than the nominal value of the coin. Similar with silver coinage until 1964.

Up until about 80 years ago, a $20 dollar gold coin was worth less than $20 in gold. Now its' $1000 in gold (factoring out any numismatic premium).

Stocks, on average, have gone up in fits and starts as well. Its hard to ignore the many years when stocks returned nothing while inflation ate away at the value of the dollar (1960s and 1970s), and its hard to ignore the negative returns of gold throughout the 1980s and 1990s.

For the last ten years, just about anyone who bought gold has made money, given that gold is at all time highs. However, stocks are where they were 10 years ago, and, given the nature of dollar cost averaging, and what happened to the NASDAQ, its fair to say that unless someone timed the markets well, most people are underwater in nominal terms in stocks.

So, here we are, the end of 2009, in the midst of a depressive recession. Up to our gills in national debt. Losing jobs like a fish sheds scales. How does one survive and thrive?

Live not only within your means, live beneath your means. Save your money. Is cash an investment? No. But you still need it to pay your bills. What's a good investment now?

I like the commodity space, the story there is intact. Precious metals will let you sleep at night, but they may lose half their value in the next few years, or, do nothing. You don't know.

It makes me nervous to see all the commercials selling gold on TV. Reminds me of the late 1990s with stocks, and the mid 2000s with real estate.

Bonds are clearly not the place to be. You get paid next to nothing to hold debt denominated in a currency losing its value, with the price of the bond bound to decline as interest rates rise.

Real estate is a local investment. You want to buy where people are moving to, not where people are moving from.

Its hard not to like some foreign currencies. Its hard not to like the Aussie with interest rates at 3% and soon to climb down under. FXA works.

I'm hoping for a pull back in metals, stocks, and foreign currencies like we got last year.

Oct 03 03:49 PM

[nmelendez:]

Look, gold is only used as a retainer of value. One ounce of gold today buys the same as one ounce bought in 1935. That's all it is. A retainer of value, nothing more. I would rather have 1 ounce of gold than 1000 dollars. Dollars do not buy the same 100 years from now.

Oct 03 10:25 PM

[anarchist:]

I'm waiting!!, wrote a GLD 101 covered call some time back and it looks like it's going to expire again without being called away.

Oct 03 10:36 PM

[roy piper:]

I do not look at gold as an investment per se. I see gold going up as simply an expression that the government is debasing the currency and stealing from me, and gold is a way to avoid this. That is, until they make owning gold illegal again.

Oct 05 04:05 AM

[Russ Wetherill:]

Gold at 3,000? Why not 30,000? As long as you're making outlandish and unsubstantiated claims why limit them to the merely implausible?

The problem with buying commodities in general, and gold in particular is that you are essentially placing bets on whether the value of the asset will go up or down from here. Gold can help to preserve wealth if purchased at the right value, but can destroy it if purchased at too high a price.

I prefer buying gold companies which make profits and pay dividends over purchasing gold bullion or coins. So long as their production costs are lower than the gold price then they make profits. The better run companies, like any other industry, have lower costs and greater profits.

The problem with gold bullion is that there is only one spot price that is dependent on the rest of the economy, not on the business acumen of the management of particular companies.

Overall, gold prices and gold production are growth areas. But don't get carried away or the gold bubble will inflate and then burst. If and when this happens, and all of your assets are in gold, then instead of preserving your wealth, plummeting gold prices will destroy it. Keep it rational at 5-10% of assets.

Oct 06 01:01 PM

[Tanutamen:]

"52 week lows against several currencies" none mentioned!
You are not speaking of USDJPY are you, Rick Santelli yelled on Sept 28..."USDJPY at 10 yr low..." when it wasnt, the low then was some 80pips above Jan 21-09 low....but who cares just propaganda.., very much like "States having secret meetings to switch from U$D..." that too ,was propaganda...media "agents" helping their cohorts position(s)...economic subversives they are

Folks now seemingly "cheer" US(or $) demise...? strange...What happened to the "pull together" like on 911, That too was an attack...but ahhh a financial "attack" is different...?

$546.24 current expected value on Gold....if high is broken, expec value moves up at half the rate of price increase...Sam who has the most Gold, will be glad to sell you some at higher prices...

Oct 24 01:04 AM