Can Gold's Bull Market Continue?

If confidence in the Dollar is restored, that will be the day to sell gold. But it looks a long way off...

IN JANUARY 2007, the Gold Price stood around $600 an ounce. By the end of January 2008, the Gold Price had touched a new record peak of $929 an ounce.

   The rapidity of that – some 50% inside 12 months –invites the question: Can gold's bull market be sustained?

   I have expected for some years that the price of gold price would in fact rise to $1,000 an ounce, and I still regard that as a reasonable forecast. But even $1,000 an ounce no longer looks all that impressive. It is the equivalent of about $400 in real terms, if one takes 1980 as the base year.

   To reach a new high in real terms, gold would have to rise to about $2,500 an ounce, and that is still a long way off.

   The latest sharp increase in the Gold Market has been caused by anxieties about the power supply crisis in South Africa. The normal rule of investment would be that interruptions of the power supply are likely to be temporary. In terms of labor militancy, a power close-down is like a strike, and the rule is "buy on a strike, sell on a settlement."

   However, the electricity supply situation in South Africa is particularly worrying for long-term gold mining output, not just the short term.

   The South Africans have in the past supplied electricity to Zimbabwe, which has now had to be cut off, accentuating the economic crisis of the Mugabe regime. The cause of the current shortage is the failure of South Africa to build those new power stations which the South African economy requires. It takes a decade or so to develop a major electrical supply program.

   There has also been inadequate maintenance. Local observers think that there will be a considerable delay before an adequate supply is available in the gold mines. There will not be a quick fix.

   However, the Gold Price is influenced by many factors, of which physical supply is only one. Gold is a unique commodity in that well over 90% of all the gold even mined is thought still to be in existence. Obviously this is true of bullion, but it is also true of jewelry. There are, of course, industrial processes which effectively destroy the gold they use, but even then the metal is so valuable that it pays to recover and reuse it wherever possible.

   Normal price schedules assume a relationship between production and consumption which does not determine the price of gold. The best way to understand the Gold Market is to regard gold as a kind of shadow currency, competing with national fiat currencies, and influenced by expectations of inflation and global movements of interest rates.

   However, this is quite complex. For instance, the fear of recession, such as exists at the present time, normally produces expectations of lower interest rates, which will reduce the carrying cost of gold, and tend to raise the Gold Price. Yet the fear of a recession is, essentially a fear of deflation, and gold is regarded as a hedge against inflation.

   In other words, the demand for gold is not determined – historically – by any single factor, except possibly for fear. Gold can be seen as a defense against a number of different threats.

   At present, the weakness of other currencies, particularly of currencies normally used as national reserves, is probably the strongest reason for gold’s long term rise in Dollar terms. The world has too many dollars. That situation seems unlikely to change in the near future.

   If confidence in the Dollar is genuinely restored, that will be the day to sell gold. It is a day which still looks a long way off.