0.cached.png
By Emily Flynn Vencat
Share
Newsweek is a Trust Project member
See more of our trusted coverage when you search.Prefer Newsweek on Googleto see more of our trusted coverage when you search.
There is no bull quite like a gold bull these days. After a roller-coaster week, gold closed Friday at $658 an ounce, down sharply from the 26-year high of $730 set the week before. Predictably, the market has started to murmur "bubble," but the bulls are unfazed. Many forecast gold topping $1,000 an ounce, and private predictions go as high as $15,000. Michael Lynch-Bell, head of mining and metals at Ernst & Young, says the potential is virtually limitless: "In the 1970s, oil projections just went up and up to the $100 a barrel level. People thought it was ridiculous, but just look where we are today. Gold reaching the thousands is only as absurd as that."
The bullish case goes well beyond the familiar image of gold as a haven in uncertain times. Demand has shot up for gold both as jewelry, due to exploding wealth in the nations of Asia and the Middle East, and as an investment, due to the rise of funds that make it easy for individuals to trade in gold. Combine this with the fact that global output of gold has been falling, despite the price boom, and you can see the makings of a fundamental shift in prices. In a new report Goldman Sachs argues that this is exactly what has happened, quite suddenly. "The equilibrium price of gold was $350 an ounce for the last 20 years," says Jeffrey Currie, head of commodities research at Goldman. "Six weeks ago, gold repriced itself at an equilibrium value of almost twice that--$650 an ounce."
How does that happen? Gold is an atypical commodity, in that it has few practical uses (unlike oil, say) is rarely consumed (except for a few industrial applications) and therefore raises no fears of scarcity, a factor critical to the price of other commodities. Mined gold stays in circulation, mostly in the form of jewelry. So gold is seen more as a store of value--a form of currency--than as a precious metal like copper or tin. Indeed for many years, Goldman's charts show, gold mirrored the dollar, floating around that equilibrium price of $350 in a close, inverse relationship with movements of the greenback. Since the dollar was strong and stable, gold was weak and stable.
Read More on News
Then came the tectonic shift. In late 2005, as the demand pressures cited above began to gather, the link was broken: gold began to rise much more rapidly than the dollar fell, coming back into line only a few weeks ago, but at a higher equilibrium price of about $650. Goldman expects the new equilibrium to drift upward to $800 before settling there early next year, but notes that gold could still spike higher if the dollar falls dramatically. "Gold is still cheap in historical terms," says Currie. The record price of $851 set in 1980 would be equivalent to $2,149 today.
Bulls scoff at talk of a bubble, even after a doubling in price since 2003. One reason is the advent of exchange-traded funds, which allow small investors to trade commodities like stocks on screen and paper. The first gold ETF launched in Australia in 2003 and there are now a total of five. As a result, total annual demand for gold as an investment, worldwide, rose 37 percent last year, and the holdings of gold ETFs jumped from $1.2 billion at the beginning of 2005 to $10.2 billion today. "It's done even better than we could have dreamed," says Owen Rees, chief marketing adviser at Exchange Traded Gold, which represents gold funds.
There are plans to open similar investment funds in the Middle East, where buyers are scooping up the real thing. Led by double-digit gains in India and China, global demand for gold jewelry increased 5 percent last year to a total of 2.7 billion tons. Furthermore, recent industry intelligence indicates that the world's central banks, who have been net sellers of gold since 1989, are reversing course. The World Gold Council and Goldman Sachs say there is strong evidence that the banks of Russia, China, several Middle Eastern countries and Argentina are looking to buy gold in the near future as a way of diversifying currency reserves away from the dollar.
At the same time, gold supply is stagnating. After prices bottomed at $252 an ounce during the late '90s mining companies cut spending and stopped exploring. Geology grads avoided gold, leaving a shortage of skilled workers. Now, as prices recover, mines can't keep up: gold extraction rose by only 1 percent last year. Given the time it will take to ramp up production, supply is expected to lag demand until the beginning of the next decade at least.
To gold bulls, this is a win-only situation. While most investors are sweating over the Fed's next move, gold bugs are not. Hong Kong's Dr. Doom, Marc Faber, who correctly forecast the global commodities boom in 2001, says that if the Fed stops raising rates, the continuing flood of cheap dollars will continue to drive up the price of gold. If the Fed raises rates, ending the era of easy money and slowing the economy, investors will still buy gold, as a hedge. His call: gold at $6,000 within the next 10 years.
Submit Correction
View Editorial & AI Guidelines