Editor's Note: Catch Frank Holmes at the upcoming Kitco Metals eConference September 12-13, 2010. A not-to-be missed event featuring Ron Paul, Marc Faber and other industry heavyweights. The eConference is free with Pre- Registration www.kitcoeconf.com.

Gold has the potential to double within the next five years, and if governments stumble with their policies, it can go even higher, said Frank Holmes, CEO of US Global Investors.

“When Obama gave money to stimulate job creation, a lot of that money went to State governments and not into the private sector, where it was really needed most. Now we’re dealing with a high unemployment rate that won’t go down, which is leading to increasing anger that you can see in the approval numbers. If that was to accelerate then you could see gold taking off faster,” Holmes said in an interview with Kitco News.

“I think that gold can double over the next five years, comfortably; that is a 15% compound on rate of growth. And that is what I’ll stick to,” he said. “There are not many asset classes that can demonstrate that,” Holmes said.

He said, “If you are a linear person and you use linear models - gold should be at $50,000 an ounce.  If you go to inflation adjusted prices then gold should be at $2,300,” he said.
Holmes’ firm tracks government social programs to determine whether they are based on social investing or social welfare.

“Giving out food stamps does not create jobs; it creates a society addicted to government checks.  That’s not sustainable – a society that turns around and starts updating all their roads (and )airports is,” he said.

“Why not update the L.A airport? Build a speed-train from LA to San Francisco and create 1 million jobs. Why not re-do the roofs in New York so that they are white and not dark asphalt and they will use less CO2 and create a million green jobs?” he questioned.

When you create programs such as these you have job creation, said Holmes.

“That is what the Chinese have been focused on; social spending for infrastructure versus social welfare.”  They're very conscientious in fine-tuning social stability and job creation year after year, he said.

Instability

The operative word for investors is “instability,” said Holmes. “When fiscal and monetary and social policies are misaligned then the currency goes through a period of inflation or deflation and if that is strong enough that all of sudden gold performs.”

During 1997-1998, when President Clinton was in power the U.S.  had a surplus and maintained positive interest rates,  said Holmes.

“President Clinton had 3% interest earned above the inflationary rate and you had a surplus budget, gold was $250 an ounce, unattractive as an asset class,” said Holmes. “Today, we have the opposite, we have massive deficits and we have negative real interest rates.”

Holmes also subscribes to an opposite view that many analysts hold, that the gold price will not rise without inflation. “I know it is concept that opposes the conventional opinion,” said Holmes.  

“When you are earning less on your 90-day piece of paper or a five-year note and it is less the inflationary rate, then all of a sudden gold is attractive as an asset class,” said Holmes.

During these periods, governments usually need to increase their deficits by escalating their borrowings to support the economy. This also supports gold as safe money, in addition to its beauty as jewelry, he said.

The twin engines of negative real interest rates and government deficits tend to make gold a very attractive investment.

“If deficit spending looks like it is sustainable and you have low interest rates to fight deflation then gold performs, because you get currency devaluations.  History is just replete with it,” he said.  

Emotional Buying

Holmes said it is in the seven most populous countries in the world where you find the strongest emotional attachment to the metal.

In September we usually see the emotional buyer emerge during Ramadan, Diwali, Christmas and then Chinese New Year. 

“You have a different proclivity. Now we are half-way through the holy month of Ramadan and then we go into the wedding season, these are very significant factors,” said Holmes.

  While some analysts are concerned that the high gold prices might discourage buyers, Holmes said it is more important to look at price volatility.

“We have seen that any time gold spikes $100 dollars, the demand drops. Anytime gold drops $100 dollars quickly, the demand heat picks up and these countries act on the emotional giving factor,” he said.

Central Bank Buying

India’s central bank gold buying was a pivotal point for the metal last year, said Holmes.
“Not only are they huge consumers for retail, all of a sudden they are making another decision and moving from price takers to price makers,” he said.

Holmes said that there are two types of buyers of gold: one, he terms the price takers, who are "basically a buyer of gold for jewelry."  The second group, he calls the price makers. These are people who are buying gold as an investment.

“Gold is clearly becoming an important part of that, and I think that phenomenon will grow. As it does, we will see gold trade at higher prices,” he said.

Another tipping point for gold was in 2005 when Russia decided to take 5% of foreign exchange revenue from oil and redeploy that back into gold as a reserve, said Holmes. “Gold basically hasn't traded below $500 since then.”

However, while some comments have been made that gold is currently acting as the ultimate currency, Holmes does not agree. 

“I don’t look at it that way.  I look at it as having a diversified portfolio, having exposure to gold and rebalance – don’t try and chase the performance. Don’t buy gold to get rich. Just like you don’t buy car insurance to hope you can get into accident just so you can collect.” 

By Daniela Cambone dcambone@kitco.com

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Frank Holmes
Frank Holmes, CEO of US Global Investors