Coming in 2006 – Gold’s New Record High

December 5, 2005 – It finally happened. Gold has climbed above $500 per ounce ($16.08 per goldgram), and settled in New York this past Friday at $503.30. That’s the highest close for gold since February 18^th, 1983, almost twenty-three years ago.

We can say therefore that gold is trading at a 22-year high, but I like to express this reality in another – and I think much more meaningful – way. Everybody who has bought gold in the last twenty-two years, nine months is now ‘in the money’. Gold is at a higher price today than the price paid by anyone bought gold during the past twenty-two years. So everyone who owns gold should be smiling because they are ‘sitting pretty’, but don’t think about selling. A higher gold price is on the way.

Prior to this year, gold was up four years in a row, and its appreciation was about 13% per annum on average. The exact results are presented in the following table.

We don’t know yet how the next few weeks will play out, but if gold ends this year at $520 (and I expect it will be at least that high), its appreciation for 2005 will be 18.9%, which is not too far from its 2001-2004 annual average.

Looking ahead to 2006, I expect that gold will follow recent experience, and appreciate, say, 15% at a minimum. If we end this year at $520, then my minimum upside target next year for gold would be about $600. Note, however, that I say “minimum”, for the reason that I am actually expecting a lot more from gold in 2006. We should be looking for gold to set a new record high next year. Though gold briefly traded at $850 for a nanosecond on January 21^st, 1980, it closed that day at $825.50, which to this day stands as gold’s record high close.

My target for 2006 is $900, which may sound fanciful to some, but I think this target is quite reasonable for the following reasons.

(1) The factors that have been driving gold higher the last five years are becoming more obvious. In particular, these are:

• Inflationary pressures are growing. Look how commodity and energy prices and even the CPI – which understates true inflation in my view – are rising.

• Today’s huge trade deficits are unsustainable. The present international monetary system is broken, and a few years from now we will look back and speak about the current system in the same way we now look back at the Bretton Woods system, which was jettisoned after it broke down.

• The growing federal budget deficit has to be financed, which cheapens the dollar. That’s why the Federal Reserve decided to stop reporting M3, as discussed in the last letter. They know what’s coming down the road, and it ‘ain’t pretty’. The Fed is going to try hiding this ugly reality by no longer reporting M3.

• There has been growing uncertainty about the outlook for the dollar in general, which is now being heightened because new incoming Fed chairman Bernanke is new and unproven. So instead of worrying about who will replace Greenspan, people are now worrying about how Bernanke will do. Greenspan’s shoes will be tough to fill, and the market knows that, making gold’s safe-haven status look even more desirable than usual.

Consequently, as the above bullish factors for gold have become more apparent, increasing numbers of people are turning to gold. The demand for gold is growing rapidly as a result, and it will continue to grow as monetary problems worsen, as they inevitably will given the unwillingness of the politicians in D.C. to face reality that they need to change their ways to save the dollar.

(2) Despite all the interest rate hikes by the Fed, real interest rates (fed funds less the CPI) remain negative. As a consequence, there is no incentive to hold dollars, which are being depreciated (i.e., losing purchasing power) day after day, week after week.

(3) Many commodities, and particularly energy, base metals and the platinum group metals, are near or have recently made record highs. Is it really fanciful therefore to forecast that gold will follow and also soon be near or at a new record high?

(4) The euro is no longer a safe haven. From the French and Dutch votes rejecting the European constitution in May up through the riots in France, the news in Europe has not been good. Therefore many have changed their view of the euro as being an alternative to the dollar. Gold is now being viewed as an alternative to the dollar, even within Europe, which explains the rapid rise of gold since May in terms of euros.

(5) Gold is also being viewed as an alternative to all national currencies, and not only the euro. For this reason, gold is rising against all national currencies to a degree not experienced since the 1970’s, and we all know what gold did that decade.

In summary, gold is money, and people are becoming more comfortable with the safety and security afforded by gold as the only money that is no one’s liability. This is the same underlying feature of gold that drove gold higher in the 1970’s, but we are only a few years into this present gold bull market. If the 1970’s are anything to go by (and I think they definitely are), then there is a lot of upside coming in gold’s bull market. Some of the more important reasons for this conclusion are:

(1) Inflation is going to worsen in the year ahead. There is a lot of inflation ‘in the pipeline’ yet to be reflected in the CPI.

(2) Gold has been lagging other commodities (and even other asset classes like real estate, stocks, etc.), so as I see it, gold has a lot of catching up to do.

(3) A lot of people who normally own gold are watching from the sidelines. The $500 level is widely watched around the globe, so now that gold has cleared that level, it is an international buy signal that I expect will send gold higher very quickly as new buyers jump into the market. Also, the shorts must be getting nervous, so I expect more buying from them too now that gold has cleared $500.

(4) Probably most importantly, gold is still very cheap by historical comparisons. Gold’s $850 record high is about $2,180 on an inflation adjusted basis, which is more than four times higher than the present gold price. What’s more, my Fear Index is not only still near record lows (see the following article), it’s still below the level reached just before president Nixon broke the dollar’s link to gold in 1971. Gold is very cheap indeed.

Over the past several years, gold has been accumulated by the ‘smart money’ that recognized that gold was undervalued. These buyers were not the average Joe Bloggs, who remains out of the market. But the average Joe is going to start buying now that gold has cleared $500 and continues its climb toward $600.

I expect gold to go through $500 quickly, i.e., days – not weeks or months. Look at the way gold has been trading the past few weeks. Every dip is well bought because there’s so much money waiting on the sidelines to buy gold. This new money trying to enter the market knows the long-term outlook for gold remains positive. And now that the international buy signal at $500 has been triggered, I expect this new money destined to come into the market will send gold higher very quickly as new buyers jump into the gold market looking for a safe haven.