Gold: $2011 by 2011


By Barry Stuppler

Jul 28 2008 10:44AM


(June 9th 2008) - In the month of April 2004, when the price of gold averaged $408, I wrote and published an article entitled "The Perfect Golden Storm." The article, still posted at, began, "An array of forces is converging to drive gold toward and probably beyond its 1980 peak of $852 per ounce, creating exceptional opportunities for investors."

Four years later, gold has surpassed its 1980 peak. On March 17, 2008, the London PM Gold Fix set an all-time record of $1011.25. Gold averaged $968.03 for the month of March. Investors who added gold to their portfolios in April 2004 at the average price were up 137% in four years — a performance that has trounced the stock market and just about any other investment alternatives.

If you are one of those fortunate investors, or you bought later during the run-up but are nevertheless showing a healthy profit, you are now faced with these questions: Hold? Sell? Buy more?

If you are considering buying gold for the first time, you too are faced with a question: Have I missed the boat? Or should I get on board?

When they look back at the previous record of $852 per ounce, many gold investors and analysts think, OK, we’ve surpassed that price in nominal dollars, but where are we if we take inflation into account? Based on the Consumer Price Index (CPI), which underestimates real inflation, $852 in 1980 was the equivalent of $2403 in 2007. Does that suggest we can expect gold to more than double again? If so, when? Will gold hit $2011 by 2011?

In addition to adjustment for inflation, knowledgeable investors consider several key ratios when evaluating the price of gold. For example, as "Metal Matters," a January 2008 report from Scotia Mocatta (a division of the Bank of Nova Scotia), explains, "over the past 30 years 1 oz of Gold has on average bought 17 barrels of oil. Based on this, Gold price could be as high as $1,700/oz. The average level of the Dow Jones in the 1980’s equated to 5oz of Gold; this would suggest a Gold price of $2,600/oz and in 1980 when Gold prices peaked at $850/oz, prices that year averaged $614/oz. Adjusting those prices for inflation would now give a high price of $2,000/oz and an average price of $1,450/oz."

That’s a lot of numbers, all significantly higher than the current price of gold. Let’s try to figure out what is most likely to happen, based on the forces behind the numbers.

The current bull market for gold started in 2001. My prediction in April 2004 that the bull market would continue for years was based on "interrelated forces that are merging into a perfect storm propelling the price of gold." I listed, and then described in detail, five such interrelated forces (in a somewhat different order):

  • Limited supply of gold
  • Decline of the US dollar
  • Interest-rate bind
  • Investment climate
  • Global instability

Today, the same five forces are combining — with even greater fury — to drive the price of gold higher. The chart shows that, like most other investments, gold zigs and zags. But the overall direction has been up. I believe that the forces generating that rise will continue to do so at least through the end of 2011.

I will summarize what I wrote about each of the five forces in 2004, then update the analysis to 2008. First, though, we can learn a lot by comparing the current bull market in gold to the previous record run-up in 1980.

How does the current gold bull market compare to the 1976-1980 bull market?

These charts show that from a low of just over $100/oz. in August 1976, gold worked its way up to $300/oz. by August 1979. Then came a much steeper rise. By January 1980 gold had spiked to $852/oz. After taking three years to increase 200% from $100 to $300, gold rose another 180% in just five months.

The first (larger) chart above, the 10-year chart from 1988 to the present, shows that the current bull market started from a low of $252 in March 2001. Gold rose to $700 by April 2006, and to $1,000 by March 2008. Gold took five years to increase by 220%, then zig-zagged up another 43% in two years. We have not yet seen anything remotely resembling the steep 5-month, 180% run-up that began in August 1979.

What was behind the 1979-1980 spike in the price of gold? In two words, the Iranian Revolution. Since World War II, one of the unifying themes of US foreign policy has been to control the Middle East and its oil. Two pillars of that strategy were US alliances with Israel and Iran. One of those pillars was knocked down when, after a year of demonstrations, marches, and strikes, the pro-US Shah of Iran fled the country in January 1979, followed in February by the return to Iran of the exiled Ayatollah Khomeni, the defection of the Shah’s army, and the proclamation in April of the Islamic Republic of Iran. Throughout the world, people realized that a fundamental shift in the balance of power had occurred, and that Islamic fundamentalism was a new and disruptive player on the world stage. This became even clearer in October when 52 staff members of the American Embassy in Iran were taken hostage, and when a drop in Iranian oil production led to sharply higher oil and gas prices and long lines at gas stations.

Investors did what they generally do when they are panicky and uncertain about the future. They dumped paper assets such as stocks and bonds and increased their holdings of real assets such as gold. The value of stocks and bonds depends on the smooth, predictable, profitable operation of business as usual. Gold is a scarce commodity with intrinsic value that increases when inflation, economic crises, and war threaten profits and the flow of tax revenues. (A companion article to “The Perfect Golden Storm,” entitled "Own Gold Always," explains why prudent investors always include gold in their asset mix. This article is also still available at

As panic about stability in the Middle East and the effect of the Iranian Revolution on OPEC subsided, the gold price plunged even faster than it had risen, forming the down side of the 1980 spike.

Smart investors in gold sold most of their holdings before the top. How did they know it was time to sell? Gold was the talk of the town. Gold bars and bullion coins appeared on the covers of business magazines, Wall Street pundits talked up gold on TV, and the "man in the street" — taxi drivers, bartenders, clerical workers — talked about making a killing by buying gold. Gold was the "" of late 1979 and early 1980.

Nothing resembling that gold craze has taken place in the current bull market. Gold does not regularly appear on the front page of the Wall Street Journal or on the covers of Forbes, Barrons, Money, or Business Week. And the “man in the street,” focused on gasoline approaching (or passing) $4, is barely aware that gold is making record highs. Gold’s rise through $1,000 did not even make the front page of the New York Times or the Los Angeles Times — not even the front page of the business section. The current bull market has not yet had a spike similar to the one that climaxed the 1976-1980 bull market.

Today’s gold market is more broadly based

In terms of the number of participants, the gold market in 1980 was a sliver of what it is today. Two major factors have broadened the market: the growth of the Chinese economy and the advent of gold ETFs.

In 2002 individual Chinese investors were permitted—for the first time since 1949—to buy and sell gold in the form of contracts on the Shanghai Gold Exchange. The rules were further liberalized in 2005, to enable investors to buy and own physical gold bullion. In 2008 a number of products have arisen that enable Chinese citizens to trade gold futures contracts over the Internet. These legal changes came about because of the rapid growth of the number of Chinese with enough income and assets to invest, and the centuries-old tradition of investing in gold. In a country with a population of 1.3 billion, the wealthy + the middle class, while still small in relative terms, is already larger than the entire population (301 million) of the United States. Similar increases in investment purchases of gold are taking place in Russia, in Southeast Asia, and in a number of oil-rich Middle Eastern Countries.

Gold-market history was made in 2003. An exchange-traded fund (ETF) called Gold Bullion Securities began trading on the Australian Stock Exchange, under the symbol GOLD. GOLD enabled investors to buy and sell gold just as they would buy shares of a stock. One share of GOLD represents 0.1 oz. of gold held in a depository by the fund. As investors buy more shares, the fund buys more gold.

Since 2003, several other gold ETFs have begun trading. StreetTRACKS Gold Shares (GLD), which began trading in 2005 on the New York Stock Exchange, is by far the largest. As of August 2007 these funds held 628 tonnes1. of gold in storage — a far larger investment than even the World Gold Council, which initiated the funds, envisioned. At $1,000/oz., that’s a little over $20 billion worth of gold.

Tens of thousands of investors buy gold ETF shares on a regular basis, just as they would buy mutual fund shares or contribute to a retirement plan. Others buy on dips in share price. The increase in demand for gold generated by the gold ETFs tends to put a floor under the price of gold and drive the price back up when it retreats (see the 10-year gold chart above).

Now let’s see if the same five forces that have propelled the current bull market are likely to continue for several more years.

Forces driving the current bull market in gold

1.Limited supply of gold

Much of this section comes from The Perfect Golden Storm, because the supply fundamentals are similar to what they were in 2004.

The investment aphorism, "Bear markets beget bull markets," is especially apropos of gold. During the 18-year bear market in gold from 1982 through 2000, mining companies had little incentive to explore for gold. In fact, they choose not to develop most existing properties because the cost of producing an ounce of gold would have been too high relative to the depressed price of gold.

The mining companies instead relied on their lowest-cost projects. As a result, the easiest gold to mine and refine was depleted. The companies expanded by merger and acquisition rather than exploration. Merger and acquisition, of course, added nothing to the world gold supply. In fact, it tended to reduce the supply when merged companies concentrated their attention on their most profitable mines.

Once gold in sufficient concentration to mine profitably is discovered, it takes an average of seven years to begin sustained commercial production. In addition to the time required for geological studies and planning and building infrastructure, a new mine must go through the permitting process. Mining gold has significant physical and chemical effects on the environment and is therefore subject to intense governmental regulation in every gold-producing country.

During the bear market, central banks, believing that they were storing an asset that might continue to decline in value, sold thousands of tons of gold. As a result, they now have less to sell. In an effort by banks to regulate the market, The Central Bank Gold Agreement (The Washington Agreement), signed in September 1999, limited its signatories to selling no more than 400 tons of gold per year over the five years ending September 2004. The agreement was renewed in March 2004 for the five years ending September 2009, with the annual limit raised to 500 tons. Concerned about the risk of holding dollars, the banks have less reason to sell and many have announced no sales at all or annual sales far less than the maximum permitted by the agreement. Some dollar-rich central banks, such as those of Russia, China, and oil-producing Middle Eastern countries, may be buying gold to diversify their assets.

A number of other factors have held back the discovery and development of new goldmines and have restricted production from existing mines:

  • Bloomberg News reports (March 17, 2008) that the Canadian mining industry (many of the world’s gold-mining companies are headquartered in Canada) has 9,000 positions for geologists to fill, and there will be only 1,200 geology majors earning bachelor’s degrees this year. They are in such short supply that their starting salary will exceed that of US MBA graduates. Mining engineers, pipefitters, welders, and other key specialists are also in short supply. "The shortage of mining expertise is particularly acute in Canada, Australia and the United States, said Frances McGuire, CEO of Major Drilling Group International Inc." Because of this shortage of human resources, gold that could have been discovered during the bull market has not been discovered, and there have been delays in bringing gold that has been discovered into production.

  •  South Africa, which has produced 30% of the gold in circulation today, is in the midst of a shortage of electricity. Electricity is essential to underground ventilation and drainage. Electricity to mines was turned off for five days in January, causing a 16.5% decline in monthly production compared to January 2007. Then quotas were imposed on gold mines of 90% of historic electricity use, later raised to 95%. This electricity shortage is the result of crumbling infrastructure and will take years to fix.

  • Leftist heads of state in Latin America, such as Hugo Chavez in Venezuela and Evo Morales in Bolivia, have changed the terms of agreements between their countries and oil and gas drillers and mineral miners, and they have threatened to not renew licenses on foreign-owned mines. Fear of restructuring of deals, and even of nationalization, has slowed down development of new gold mines in these countries and has created reluctance to invest in new projects there.

Proposed International Monetary Fund sale of gold

The International Monetary Fund has decided to raise funds by selling about 400 tonnes (12.5%) of its gold reserves, worth about $11 billion. The sale requires approval from the US Congress, which will probably give its approval. It is widely believed in gold circles that central banks and/or Middle Eastern or Asian sovereign wealth funds will arrange for private off-market purchases of the IMF’s gold. It is an opportunity for these institutions to purchase large quantities of gold without driving up the purchase price. For ordinary investors, these private sales mean that IMF gold will not come onto the market and drive the price down. Perhaps that’s why the price of gold actually went up when the IMF sale was announced.

Bottom line: As the price of gold increases, some individuals will raise cash by bringing gold jewelry and bullion coins to the market. That source cannot compensate for reduced sales by central banks and the inability of the mining industry to rapidly increase output. Therefore, as demand for gold increases, the price will continue to rise.

The next four forces all combine to increase demand for gold.

2. Decline of the US Dollar

The world price of gold, like the world price of oil, is expressed in US dollars. Therefore when the value of the dollar declines the price of gold (and oil) increases. The price of gold also generally trends up when buyers and sellers of gold believe that the value of the dollar is likely to decline in the future. From January 2001 to March 2008 the dollar fell 51% against the euro and 19% against the yen. There is widespread belief among economists, investors, and others that over the next several years, with ups and downs, the dollar will continue its downward trend, primarily because of the following factors:

Increase in money supply

The meltdown of the US housing and mortgage markets has led to a credit crunch in the financial industry, a rise in unemployment, and contraction of consumer spending. In their efforts to stave off a recession, the US Treasury and the Federal Reserve Bank are injecting hundreds of billions of dollars into the economy, in a variety of ways. The tax rebate checks sent out in May 2008 are one example. Another, which the Fed has been pushing since August 2007, is low-interest, short-term loans to commercial banks, collateralized by shaky paper assets such as mortgage-backed bonds. In March 2008 (simultaneous with backing the Morgan Stanley takeover of Bear Stearns with a $29-billion guarantee) the Fed broadened its rules to allow investment banks to also go to the "discount window" for such loans.

Since 1971, US currency has not been backed by gold or silver.  That enables the Treasury and the Fed to make these loans by "printing money." Before the electronic age, they would literally "print money," which banks would pick up at an actual window, much as individuals do at a savings bank, and take to vaults. Now, paper, ink, printing presses, and transportation in armored vehicles are no longer necessary. An electronic notation by the Fed is all it takes for, say, Bank of America to gain $20 billion in "cash," using as collateral bonds or other securities for which there may be no market.

Such injections of cash, particularly in periods where production is not expanding rapidly or is contracting, are inflationary. They result in more money chasing the same amount or less of goods and services, causing the value of each dollar to decline and prices to rise. (The Bank of England and the central bank of the European Union are pursuing similar inflationary strategies to get credit moving again.)

"Printing money" will probably continue and even accelerate. Bear Stearns is unlikely to be the only financial institution requiring a bailout. And pressure is increasing for the federal government to enter the market and purchase mortgages, so that they can reshape the terms and enable some homeowners who would otherwise have lost their homes to keep them. A number of key industries with strong lobbies are profiting from the weak dollar, including exporters and those segments of the travel and hospitality industry that benefit from tourists attracted the US by the cheap (for them) dollar. Finally, the federal government itself is the largest debtor in the world. By printing money and reducing the value of the dollar, it essentially reduces it debt.

Huge, growing federal deficit

US National Debt from 1940 to Present

As of mid-April 2008 the government of the United States owed its creditors $9.45 trillion.2. As a result of annual budget deficits, the national debt started growing steeply in the mid- to late 70s, surpassing $1 trillion for the first time in 1981. Since September 2006 the debt has increased at an average rate of $1.63-billion per day. The Congressional Budget Office projects that the gross national debt will reach $10.5 trillion in 2010 and $12.7 trillion in 2017.

In fiscal year 2007, the interest on the national debt was $238 billion. That’s an average of $652 million per day, seven days a week. In other words, about forty percent of the average daily borrowing of $1.63 billion is spent on paying interest on previous debt. If you were to manage your own budget this way, would you foresee doubts developing in your creditors’ minds about your ability to repay them?

Similar doubts are affecting those who loan money to the US government. Holders of dollars and dollar-denominated investments used to know that their money was backed by gold. In 1933, in the depths of the Great Depression, President Roosevelt signed legislation that denied residents of the United States the right to claim gold for their greenbacks. Foreign central banks, however, could still demand an ounce of gold from the US Treasury in return for a fixed price of $35 dollars. In the 1960s, with the war in Vietnam fueling inflation and undermining confidence in the dollar, many foreign central banks did just that. To prevent the US from running out of gold, President Nixon took the dollar off the gold standard. As of August 15, 1971, the dollar was backed only by the power of the US government to declare it "legal tender for all debts, public and private."

Huge and growing national debt has contributed to global skepticism about the value of the US dollar, especially given that the federal government has the unilateral power to pay its debts in a way unavailable to you. Through the Treasury and the Federal Reserve System, the government has the power to create money by increasing the supply of dollars. The transformation of the United States government from the world’s biggest creditor to the world’s biggest debtor has played a role in the rise in the price of gold to its present level from the $35 it was pegged at until August 15, 1971. No end to this trend is in sight. In fact, without huge increases in US taxes, huge cuts in federal spending, or both, growth of the US national debt is built into the structure of the federal budget3. and can only accelerate.

Huge, growing trade deficit

Every year since 1992, the United States has imported more goods and services (measured by price in dollars) than it has exported. The difference is known as the trade deficit (or, in many of the years prior to 1992, the trade surplus). A weaker dollar can lower the deficit by making US goods cheaper overseas and foreign goods more expensive here. But despite the weakening of the dollar against the euro and the yen, the deficit for 2006, the last year for which the final figure is in, was a record $764 billion, up from $716 billion in 2005. To see the trend over a longer period, here’s what I wrote in 2004: "In calendar year 2003 the United States imported almost half a trillion dollars more in goods and services than it exported. The precise figure, known as the trade deficit, was $489.4 billion. That’s a 17% increase over the previous record, set in 2002." Of course, the tremendous jump in the price of oil accounts for a significant portion of the deficit, and the developing recession in the US is starting to cut into imports while the cheaper dollar is helping raise exports. Thus the annual deficit may decrease. However, long-range, the price of oil will probably continue to rise and US manufacturing will probably continue to struggle against manufacturing in China and other areas of cheap labor in Asia, Latin America, and Africa. Thus the trade deficit will remain with us for the foreseeable future, guaranteeing continued US dependence on financing from abroad.

Dependency on foreign financing

Where did US consumers (including businesses and government agencies) get the extra three quarters of a trillion dollars (in 2006) to pay for these imports? The EU, Japan, China, Korea, and other countries that export more to the US than they import from the US end up with a surplus of dollars. They invest much of this surplus in the US. For example, in addition to buying enormous amounts of Treasury Bills, Japan and China have invested billions of dollars in Ginnie Mae bonds. Ginnie Mae is the Government National Mortgage Association. Owned by the US government, it guarantees Federal Housing Administration and Veterans Administration mortgages. In other words, a significant part of the housing boom, which more than anything else had been holding up the US economy, was financed from abroad.

According to figures from the Federal Reserve, as of December 2007 foreign investors held $2.5 trillion of the debt issued by the US Treasury and other US government agencies. That is 46% of the publicly held debt. (A whopping $4.09 trillion is not publicly held because it is owed to US government trust funds. By far the largest borrowing is from the Social Security trust fund. These loans must be repaid, with interest, to finance future Social Security benefits.)

As of December 2007 Japan was the largest foreign holder of US treasury securities, at $591 billion. China was the second largest, with $478 billion.

There has also been an enormous influx of foreign capital into US stock markets and, a new development, direct investment in US firms by Asian and Middle Eastern sovereign wealth funds.

The dollar has been sinking despite all this support. When will central banks and investors in the EU and Asia decide to cut back on investing in bonds and stocks that pay off in a declining currency? Then Fed Chairman Alan Greenspan referred to this concern in congressional testimony as early as Feb. 11, 2004:

"Given the already-substantial accumulation of dollar-denominated debt, foreign investors, both private and official, may become less willing to absorb ever-growing claims on US residents. Taking steps to increase our national saving through fiscal action to lower federal budget deficits would help diminish the risks that a further reduction in the rate of purchase of dollar assets by foreign investors could severely crimp the business investment that is crucial for our long-term growth."

"Fiscal action to lower federal budget deficits” did not take place. A severe “crimp in business investments," AKA the credit freeze, has taken place. Greenspan’s 2004 testimony continued, prophetically:

"The imbalance in the federal budgetary situation, unless addressed soon, will pose serious longer-term fiscal difficulties. Our demographics — especially the retirement of the baby-boom generation beginning in just a few years — mean that the ratio of workers to retirees will fall substantially. Without corrective action, this development will put substantial pressure on our ability in coming years to provide even minimal government services while maintaining entitlement benefits at their current level, without debilitating increases in tax rates. The longer we wait before addressing these imbalances, the more wrenching the fiscal adjustment ultimately will be."

In addition to contributing to increases in the price of gold, the decline of the US dollar against other major currencies increases foreign demand for gold. Why is that? Because gold is priced in dollars. Owning gold gives foreign governments, corporations, and individuals a way to hedge against further declines in the US dollars they accept in trade and as interest and dividend payments. Furthermore, for currencies that have appreciated sharply against the US dollar, such as the euro and, more recently, the yen, gold seems relatively cheap. People who earn income in euros flock to the US as tourists because prices seem so low. In the same way, they see gold as a bargain.

Bottom line: The US national debt and trade deficit are likely to continue to increase, putting downward pressure on the US dollar. As the dollar declines, the price of gold rises. A weaker dollar also drives the price of gold upward by threatening global stability and the profitability of alternative investments.

Question: Given the decline of the dollar, rather than invest in gold, should you just buy euros and/or yen?

Answer: Such investments can serve as hedges against dollar decline, but they cannot replace the role of gold in your portfolio. Like the dollar, the euro and the yen are backed only by the promises of the governments that issue them. To keep Japanese imports flowing into the US, Japan’s Central Bank has repeatedly entered the market to push down the price of the yen relative to the dollar (although not recently). The EU may have done the same with the euro and is likely to do so in the future. The key point is that inflation is a worldwide phenomenon. In the 10 years ending Feb 2008, gold is up 222% against the dollar, 138% against the yen, and 143% against the euro. This differs from the 1985–1987 bull market, when gold rose 76% against the dollar but fell 13% against the yen and 16% against the deutsche mark (the euro did not yet exist). The move to gold from all three of the world’s major currencies suggests that the bull market will continue even if/when the dollar stops dropping against the euro and yen.

3. Interest-rate bind

The federal funds rate is the interest rate at which US banks make overnight loans to each other of balances they hold at the Federal Reserve. In April 2004, with the Fed’s funds rate at a 53-year low of 1%, I wrote, "Keeping US interest rates at their present historic lows weakens the dollar, raising the price of gold. But raising the rate, as must eventually happen, will kill the housing market, which has been the main driving force of the US economy. A return to recession and a stock market crash will send the price of gold through the roof."

To spur an economic recovery after the bursting of the Internet bubble (the NASDAQ Composite Index peaked at 5,132 March 10, 2000 and has never really recovered; it closed at 2,290 April 11, 2008) the Fed began a series of rate cuts in January 2001. Eleven cuts and three years later the funds rate had been reduced from 6% to 1%.

The reduction of interest rates lowered mortgage rates, making it easier for people to buy houses. Many people who already owned houses refinanced at a lower rate, some more than once. Home buying and cash generated by refinancing fueled the US economic recovery.

Of course, many of the buyers and refinancers were taking loans (often with little or no down payment and low initial interest rates that would reset higher) they could not afford to repay unless house prices continued to rise for years and years, enabling continued refinancing.

By June 2004 the Fed had become fearful of inflation and of a precipitous decline in the US dollar, which would lead to a drying up of the foreign credit essential to running huge federal and trade deficits. Therefore the Fed began to raise the funds rate in 0.25% increments, reaching a rate of 5.25% by June 2006.

Combined with variable-rate-mortgage resets the rate increases did indeed kill the housing market and have, unfortunately, led to recession on Wall Street and on Main Street. Layoffs in construction and real estate have led to layoffs in the financial industry and other sectors. In an attempt to forestall or limit recession, the Fed reversed course once again. In August 2007 it lowered the discount rate (the interest rate at which member banks can borrow funds directly from the Federal Reserve) from 6.25% to 5.75%. A month later it lowered the discount rate and the funds rate another 0.5% (taking the funds rate from 5.25% to 4.75%). There have been seven more cuts since September 2007, bringing the funds rate down to 2.0% and the discount rate to 2.25%.

These cuts were precipitous: the discount rate decreased 4 percentage points in just seven months. But housing prices, sales, starts, and permits continue to decline steeply, making further reductions by the Fed likely. However, the Fed’s interest-rate cuts have already contributed to the decline of the US dollar. The US Dollar Index measures the value of the dollar relative to a basket of six other currencies: the euro, yen, British Pound, Canadian dollar, Swedish krona, and Swiss franc, with the euro accounting for 57.6% of the basket. The formula was set at the start of the Index, in March 1973, to give the US dollar a value of 100. In the years since, the dollar has gone as high as the 160s. The Index dropped below 100 in 2003 but always managed to stay above 80. Currency traders, economists, and others considered 80 to be a “floor” supporting the dollar. In late August 2007 the dollar fell below 80 for the first time. It hit a record low of 72.89 in March 2008.

Bottom line: The US economy (and the economies of many other countries) is in a bind because of the record high level of debt of the federal government, state and municipal government, financial institutions, and consumers. Holding US interest rates down weakens the dollar, putting upward pressure on the price of gold. Raising interest rates can strengthen the dollar short-term, but undermines investments in the real estate and equities markets, driving investors toward gold in the longer term.

4. Investment climate

In April 2004 I wrote, "The biggest difference between investors in 2004 and investors during the 1990s is that today’s investors have been through the Internet bubble. Although some people seem born to repeat error, ‘Once burned, twice shy’ is the more common reaction to financial disappointment. Even many investors who are once again putting money into tech stocks see the wisdom of diversifying a portion of their portfolios into tangible assets. As a result, investor demand for gold, the ultimate 'hard asset,' has increased, contributing to the rise in the price of the metal. Many financial advisors who only a few years ago pooh-poohed the idea of owning gold are now recommending (sometimes only when asked) that their clients include gold in their investment portfolios. The world supply of gold in 2003 was $53 billion, an infinitesimal sum compared to the trillions of dollars invested in stocks and bonds. A tiny change in allocation toward gold would send the price of gold rocketing."

According to CPM group (a commodities research organization), "Total gold supply was reported to be 110.7 million ounces in 2007, up 6.2% from 104.3 million ounces in 2006." At an average price in 2007 of $700.11/oz, the total price of all the new gold available for sale that year was $77.5 billion. That market is still a tiny fraction of the market for stocks and bonds. For example, the market capitalization of the companies in the Russell 3000 (as of Feb. 29, 2008) is $239.4 trillion. The Russell 3000 accounts for 98% of the value of US stocks. Throw in US bonds, foreign stocks and bonds, and money in saving accounts (particularly in Japan and China, where the savings rate is high) and you can see that, "A tiny change in allocation toward gold" would still "send the price of gold rocketing."

Will investors continue to move money into gold? Well, following the bursting of the Internet bubble, many investors did move to a tangible asset — real estate. Many profited by "flipping" houses or buying houses to rent. Many others held on too long or got in too late and lost money. The contraction in the real estate market — and the threat it is posing to the financial and consumer sectors — can only make gold more attractive to investors. For example, in a February 2008 conference call for its private wealth management clients and advisors, Morgan Stanley recommended a 2% allocation to gold. That is far below the 5% I believe is always a good idea and the 10-20% that the current political/economic picture calls for. Nevertheless, even a 1% shift from US stocks to gold would represent the entry of $2.4 trillion into an annual world market of only $77.5 billion. Even a 0.1% shift would mean a $240-billion increase in demand for gold.

Economic growth in China, a country of 1.3 billion people, is creating a middle class larger than the entire population of the United States. They have invested several trillion dollars in the Chinese stock market and in savings accounts. As I mentioned earlier, Chinese law was changed to allow citizens, for the first time since 1949, to invest in gold. A March 2008 article in China View ( leads off, "A gold frenzy is spreading fast among Chinese investors, with the price of the precious metal hitting new highs even as the stock market stays stuck in the doldrums.”

As noted earlier, in 2003, in response to investor demand, the world’s first gold bullion security was registered on the Australian Stock Exchange. Investors can buy shares, each of which is backed by approximately 1/10 of an ounce of gold bullion. In December 2003 a similar security was registered on the London Stock Exchange, and a New York Stock Exchange listing arrived in 2005. Initial demand for shares in gold ETFs was While GoldNewsToday recommends that you own physical gold rather than (or as well as) paper assets representing gold such as these securities or shares in mining companies, there is no question that the increasing popularity of exchange-traded securities is raising demand for physical gold and propelling gold to a higher price.

Until recently, about 80% of the physical gold sold in the world had been used to manufacture jewelry (especially in India and other Asian countries gold jewelry is also thought of as an investment). With the 300% increase in the price of gold since April 2001, global demand for gold jewelry has weakened, and jewelry now probably accounts for less than 70% of gold sales. The decease has been more than made up for by investor demand. Jewelry manufacturers come back into the market on dips in price, which helps gold investors by putting a floor under the price. A smaller amount of gold is also required in the manufacture of automobiles, PCs, and other consumer, medical, and industrial electronic equipment. Rapid increase in purchases of consumer products in China, India, Russia, Brazil, and other fast-growing economies has raised global demand for virtually every industrial commodity, including gold.

One more potentially critical factor is affecting the investment climate: the price of oil. Oil is trading at all time highs. A number of financial analysts, including those at Goldman Sachs, are predicting oil as high as $200/barrel within two years, with corresponding run-ups in the prices of natural gas, gasoline, and jet fuel. Combined with continued decline in the housing markets in the US and Europe, oil at these levels could lead to sharp decline in share prices across many industries. If that were to occur, gold could become one of a shrinking number of profitable investment sectors.

Bottom line: The idea of putting a portion of their assets into gold is becoming more and more attractive to investors throughout the world. Investors who were burned by the Internet bubble and/or the real estate bubble see the wisdom of diversifying into gold, and increasingly wealthy segments of the population in Asia grew up on the idea that gold is a safe haven in turbulent times and can now legally buy gold. Increasing investor demand, along with jewelry and industrial demand, will continue to drive up the price of gold.

Carefully evaluate the opinions of financial advisors

Many financial advisors in the United States tend to be biased against owning gold. They continue to favor stocks, bonds, and other paper investments that fit conveniently into their clients’ portfolios. They tend to espouse views similar to these, from Bloomberg commentator Michael R Sesit. On October 4, 2007, with gold at $727, Sesit wrote, "bullion has no direct link to economic growth as do other commodities, doesn’t earn a return, offers limited hedging advantages and hasn’t kept pace with inflation. Moreover, the world’s biggest holders of gold, major central banks, aren’t overly eager to keep owning it. For investors who decide to hold gold, things may not be as easy as the past few years.” Such pronouncements are nothing new. When the price of gold dipped 9%, as it did in April 2004, when "Perfect Golden Storm” was published, a number of analysts concluded that the bull market was over. And when the price of gold jumps sharply, the same analysts often conclude that a peak has been reached. Investors who chose to hold or buy gold despite Sesit’s remarks have been rewarded by a 24% profit in the six months since Sesit’s article was published.

5. Global instability

As I mentioned earlier, the value of stocks and bonds hinges on the predictability of corporate profits. When the world is in turmoil, companies (with the exception of some that profit from turmoil, such as arms manufacturers) hesitate to make capital investments and are reluctant to hire. Growth slows; tax flows decrease. The failure of General Electric, one of the largest companies in the world, to make its earnings forecast for 1Q 2008, and GE’s reduction of its forecast for the entire year, reflects this environment. In such times, investors turn to tangible assets for a safe haven. Among tangible assets, real estate has traditionally been the largest of the save havens. But it is far from a safe haven in the US —and a number of other countries — today. Thus, more and more money chases one of the few remaining safe havens: gold.

Is the world more stable today that it was four years ago? Or less stable?

In 2004, I wrote that global instability included the following major factors:

  • Terrorist acts and threats in the US and Europe
  • Ongoing violence in Iraq, Afghanistan
  • No solution to Israeli/Palestinian conflict
  • Shaky Middle East regimes
  • Competing interests of US, EU, Japan, Russia, China

Four years later, the list would be similar, with the addition of civil wars in the horn of Africa and the disruptive effect of steeply rising oil and gas prices.

Very briefly, how has each of these situations changed? (If you follow the news and agree with me that the world is even less stable than in 2004, you may want to skip the following section and go straight to the conclusion.)

Terrorist acts and threats in US and Europe

The Perfect Golden Storm pointed out that the Madrid subway bombing (March 2004) showed that "despite losing Afghanistan as a Taliban-protected base of operations, Al Qaeda, with the help of likeminded terrorist groups, remains able to function internationally with deadly effect…. There are just too many soft targets — subways, freight and commuter railroads, ports, power plants, factories, urban centers, reservoirs, to name only some — to protect. Stepped up security at US airports is costing billions per year. It would be fiscally impossible to multiply that effort to cover other systems and sites." Unfortunately, since then, there have been dozens of incidents confirming it (even without including areas of daily or frequent terrorist attacks such as Iraq, Afghanistan, Pakistan, and the Middle East). Among the most serious, of course, was the London subway bombing of July 2005. An article in Wikipedia includes a comprehensive list of terrorist attacks around the world.

Ongoing violence in Iraq:  In 2004 I wrote, "…violence and instability continue in Iraq despite the capture of Saddam Hussein and the ongoing expenditure of billions of dollars on the military and on rebuilding the country. Is there light at the end of the tunnel? The success of the US plan to turn over political power to Iraqis depends largely on moderation on the part of the country’s majority Shiite population — a risky proposition. The possibility that Sunnis, Kurds, and Turkamen will rebel against Shiite dominance also threatens the stability of Iraq, or even its survival as a single state. The countries bordering Iraq — Syria, Turkey, Iran, Kuwait, Saudi Arabia, Jordan — each has its own interest in the outcome and its own allies within Iraq. It is hard to see how these disparate forces inside and outside Iraq will come together to produce a stable outcome. It is unfortunately far easier to envision an ongoing, and expensive, US occupation, with continuing violence and political and social turmoil."

Unfortunately, just about the same could be written today. The "surge," the hiring of Sunni militiamen, and the virtual completion of "ethnic cleansing" of many neighborhoods in Baghdad and other cities has at least temporarily resulted in lower casualties among US soldiers and Iraqis, but, based on the troop strength of the US armed forces, the surge cannot be maintained. Little progress has been made in creating a viable national government with a unified and professional army and police.

Unresolved war in Afghanistan: “Despite the ouster of the Taliban from power, most of Afghanistan remains outside the control of the new central government. The most sought-after terrorist leader in the world, Osama bin Laden, has so far eluded capture. Taliban leader Mullah Muhammed Omar has also eluded capture and is reported to have reorganized the Taliban movement and to be mounting cross-border attacks on Afghanistan from Pakistan.” That’s what The Perfect Golden Storm noted and the same is true today. The US, because of its commitments in Iraq, cannot send enough troops to turn the tide and is unable to get NATO to send enough troops and to commit them to fighting the Taliban.

"Hezbollah... the A-team of terrorists":

In 2004 then Deputy Secretary of State Richard Armitage said, "Hezbollah may be the A-team of terrorists, while al Qaeda is actually the B-team." In July 2006 a Hezbollah unit crossed into Israel from Lebanon, killed three Israeli soldiers, injured two, and captured two. During an attempt by Israel to rescue the captives, five more Israeli soldiers were killed and a tank destroyed. Israel then bombed Lebanon and launched a major invasion of southern Lebanon. To the surprise of most observers, the Israeli ground forces were unable to achieve their goal of retrieving the two captured soldiers and of destroying Hezbollah’s capacity to launch attacks on Israel. This was the first time in the history of Israel that it was not able to decisively defeat its opponents.

Iran and Syria are major financiers and arms providers to the Taliban. The Bush administration, and most other Republican and Democratic leaders, view Iran as the major opponent to US interests in the Middle East. They are displeased that Iran is emerging as the major winner in the US invasion and occupation of Iraq. The US continues to accuse Iran of supporting terrorists within Iraq, and there is still the possibility that the US will attack Iran militarily. If the US were to attack Iran, Iran would certainly encourage Hezbollah to attack US assets worldwide, including within the United States.

Saudi Arabia — shaky sheiks: The Saudi Royal Family stays in power by supporting fundamentalist clerics and buying off citizens with oil profits, while foreign residents do most of the physical work in the country. Despite the continuing decline of the US dollar, oil revenues are up because of the increase in the price of oil from $30-40 in 2004 to $110-120. Unemployment is 15%, concentrated among young people. Out of a population of 27 million, 5.6 million are resident foreigners. 40% of the population is under 15. According to the CIA World Factbook, despite diversification efforts, "The petroleum sector accounts for roughly 75% of budget revenues, 45% of GDP, and 90% of export earnings." With dollars pouring in as oil pours out, and the Saudi currency (the riyal) pegged to the US dollar, inflation was at a record 4.1% in 2007 and is expected to rise further in 2008. The picture is much the same throughout the oil-producing countries of the Middle East/Persian Gulf. Unrest in Saudi Arabia could affect oil production and shake up economies throughout the world.

Ongoing Israeli-Palestinian conflict: In January 2006 the radical Islamic movement Hamas won an election against the more moderate Fatah in the Palestinian Authority parliament and Israel cut off foreign aid to the Palestinians. Armed fights (December 2006-June 2007) between Hamas and a a US and Israel-backed Fatah resulted in Fatah controlling the West Bank and Hamas controlling Gaza. After Israel banned shipments across Gaza’s borders (January 2008), Hamas blew up a fence on the Egyptian border to give Palestinians temporary access to food, medicine, and other supplies. Rocket attacks on Israel from Gaza continue; Israeli Air Force conducts missile strikes on Gaza. A Palestinian terrorist killed eight yeshiva students (March 2008) in East Jerusalem. An Israeli-Palestinian settlement is still desperately wanted by shaky US allies in the mideast; such an agreement is not in sight.

Rift between the US and its European allies:

Since 2004 global competition for oil and other resources has sharpened, particularly with the rise in demand from rapidly growing China and India. Russia has become stronger because it controls so much of Europe’s energy needs, particularly through exports of natural gas. The interests of Russia and of the US are colliding in many of the former Soviet republics, including Kazakhstan, Ukraine, Azerbaijan, Kyrgyzstan, Turkmenistan, and Uzbekistan. In defiance of the US, Russia recently supplied Iran with fuel for a nuclear power plant. Russia has sharply opposed US plans to station a missile-defense system (which the US says is directed against Iran) in Poland and the Czech Republic, leading to divisions within the ruling circles of those countries and to protests in the streets of Prague. Germany recently sided with Russia in refusing to allow NATO to move toward extending membership to Ukraine and Georgia.

In addition, the continuing decline of the US dollar against the euro, the pound, the Swiss franc, and other European currencies such as the Czech koruna, is raising tensions by making US products more competitive vs. European products.

Bottom line: The world is at least as unstable today as it was in 2004, if not more so.

Which will come first, gold at $2011 or the year 2011?

Based on all the forces described above, I firmly believe the price of gold will continue to rise over the next several years. To answer the question I started with, yes, I believe that gold at $2011 is likely to come by 2011. For the four years from April 2004 to March 2008, the price of gold rose at an average annual rate of 25%. If it continued to rise at that rate, it would hit $2011 in about June 2011. However, the 10-year gold chart shows that the rate of increase has been accelerating since about September 2006. At an average annual rate of increase of 30%, gold will hit $2011 approximately January 1, 2011. To reach $2011 by the end of the year 2011, gold would only have to appreciate at an average annual rate of 21%.

Fortunately, I don’t need to be sure that that gold will reach $2011 by 2011 to see the logic of holding gold and continuing to invest in gold. As long as the interrelated forces I have labeled limited supply, declining US dollar, interest-rate bind, investment climate, and global instability remain in place, they will continue to drive the price of gold higher. I believe I have shown that these forces do remain in place and are, in fact, intensifying. The Perfect Golden Storm continues. Your opportunity to profit from it remains.

How should you invest in gold?

There are a number of investment vehicles related to gold. They include physical gold in the form of bullion coins or bars and rare gold coins, the gold ETFs, and shares in gold mining companies. What should you invest in? When? How much? I believe that investors in gold should have a personalized plan based on the following factors, among others:

  • Goal: Diversification of assets? Protection against falling US dollar? Capital appreciation? All of the above?
  • Available funds
  • 1-time purchase or ongoing investment?
  • Time horizon
  • Risk tolerance

1. A tonne is a metric ton, or 1,000 kilograms, which equals 2,200 pounds. Gold is always measured in tones or in troy ounces. A troy ounce is a little heavier than an avoirdupois ounce. While there are16 avoirdupois ounces to an Avoirdupois pound, there are 14.583 troy ounces per avoirdupois pound. A tonne, therefore, is equal to 32,082 troy ounces.

2. Figures compiled from US Treasury website by .

3. The three largest components of the federal budget – by far — are Health and Human Services (Medicare, Medicaid, Food Stamps, etc., but not Social Security, which is paid out of its own trust fund) about 43%; Defense, about 30%; and interest payments on the debt, about 11%.


Barry Stuppler


The opinions and statements in this article are mine and do not reflect any views or opinions of any association or organization of which I am an officer or director.