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Is $2,000/oz Gold's Next Stop?

Is $2,000/oz Gold’s Next Stop?
By Ron DeLegge, Editor
November 9, 2009

SAN DIEGO (ETFguide.com) – As people question the ability of world governments to deal with the worst economic recession of our generation, an ancient measure of value is on the rise. What is it? Gold.

Let’s evaluate some reasons gold has surpassed important barriers and see if $2,000/oz is in the cards.

Is this the “Perfect Storm?”
In February, bailout 2.0 (also known as the “American Recovery and Reinvestment Act of 2009”) was passed into law. It amounted to a $787 billion plan by the U.S. government for job preservation and creation, infrastructure investment, energy efficiency along with state and local fiscal stabilization. While large spending programs like it are hailed as financial salvation by the people passing them, they are creating what some economists are calling the “Perfect Storm.”

In many respects, the U.S. government finds itself in a fiscal catch-22. If they pay for massive bailout and stimulus packages with borrowed money, it drags a deeply indebted nation into deeper debt. If they pay for the packages by printing more money, it devalues the dollars already in circulation and creates the potential for massive inflation. 

Oddly, the most elevated federal deficit ($1.4 trillion) since the 1940s doesn’t seem to bother U.S. politicians one iota. As this weekend’s House vote illustrates, they’re poised to spend another trillion dollars or so on overhauling the healthcare system. What deficit?

Investing in Gold
Aside from owning physical gold, there are other ways for investors to obtain market exposure to gold.

In 2004, State Street Global Advisors introduced SPDR Gold Shares (NYSEArca: GLD) as the first exchange-traded trust linked to the price of gold bullion. The share price reflects 1/10th the price of one ounce of gold bullion. The trust is backed by physical gold, which is stored in the form of London Good Delivery Bars (400 oz.) in a secured vault. GLD has a mammoth $35 billion in assets making it the largest gold ETF in the world.

Since the beginning of this year GLD has risen close to 25% in value.

Another way to gain exposure to gold is by investing in stocks closely tied to the gold mining market. The Market Vectors Gold Miners ETF (NYSEArca: GDX) follows the Amex Gold Miners Index.

The underlying index contains 32 mining stocks and Barrick Gold, Goldcorp and Newmont Mining represent the three largest holdings. GDX has climbed 40.55% this year, handedly outperforming gold itself.

What’s Behind Soaring Gold?
Just as a doctor would want to find out what is causing a certain problem before prescribing medication, investors should find out what’s really causing gold’s price spike before making a buy/sell decision.

Deciphering the cause and effect equation could also shed more light on gold’s future. Isolating the cause of gold’s rise will also bring us a step closer to finding out whether $2,000/oz is achievable.

Since gold, as other commodities, is traded in U.S. dollar denominated units, the fluctuations of the greenback may have a direct bearing on gold prices. If demand for gold truly outweighs supply, gold prices measured in various currencies will go up. If a weak dollar is causing higher gold prices, gold denominated in U.S. dollars will be the main or sole beneficiary.

Beware of the Crowd
According to some estimates, up to 90% of all traders are bullish on gold. And recent activity in the gold market seems to confirm their positive bias. For example, the Reserve Bank of India just bought 200 metric tons of gold from the International Monetary Fund for $6.7 billion. Will other world central banks do the same and boost gold’s price action higher?

Many goldbugs and gold investors are recent converts. The interest in buying new investments is usually the highest when their prices are peaking. Will there be enough new gold buyers to propel gold prices to $2,000 per ounce?

After reaching a record high of $850/oz in January 1980, gold prices fell over 40% in two months. It took gold 28 years to reclaim the $850 level. Will we see a repeat incident of gold’s historical head fake?

The fact that gold has become such a popular trade should raise some red flags. The crowd is rarely right and if they are it’s usually short lived.

Is Gold’s Future as Bright as its Shine?
Gold is more than just a precious metal. Unlike paper currency, gold is not someone else’s liability. Its worth is specified by investor’s willingness to own the yellow metal. As such, gold is the only true currency.

While the destination for stocks is pretty much mapped out already, gold is likely to undergo two distinct stages over the coming years. One stage will be influenced by the extreme optimism present today, while the other stage should be closely linked to a continuation of financial turmoil.

The ETF Profit Strategy Newsletter contains a detailed forecast for gold’s two stage development, along with a short, mid and long-term forecast for U.S. stocks. If history is a correct guide, which it usually is, the upcoming twists in gold and equities will take many investors and goldbugs by surprise.  

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