Gold bull has barely begun

published 31 October 2005

With the price of gold on the up, you might be tempted to take profits on any gold holdings. But the global economy is still in turmoil and the supply of gold is tight; further price rises - of up to 700% - by the end of the decade look likely

Who'd want to be Gordon Brown these days? The UK economy looks more fragile by the day, he is going to have to raise taxes after the election, and his petty rows with his boss make front-page news every other day. Then there's the gold price. Back in 1999, when precious metals seemed to most to be a pretty pointless investment, he sold off more than half the UK's gold reserves at around $260 an ounce. It was a move that seemed to mark the bottom of the bear market in gold as surely as Tony Blair's £3.6m purchase of a house in London's Connaught Square marked the top of the bubble in UK house prices. The gold price has been in an uptrend since: towards the end of last year it hit 16-year highs at $450 and is currently trading at around $425 an ounce. So what's next for the yellow metal?

The answer is a long-term bull market. Those who have held on to gold throughout the long-bear market of the last 20 years might be tempted by the price rise over the last few years to count their blessings, sell up and move on. But that would be a mistake. To see why, think about the last bull market in gold - when the price hit $850 an ounce in 1980 (2,000% up from its lows), says Brian Durrant in The Fleet Street Letter. There was escalating tension in the Middle East, mainly centred on Iran, US government policy was in disarray abroad, oil prices were surging (they moved from below $15 a barrel in December 1978 to $39 a barrel in February 1981) and the dollar was weakening. Sound familiar? It should. The conditions that provided the background for a speculative frenzy then are fast being replicated today, and that means there are several very good reasons to hold gold.

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Gold is the best insurance Bad news is good news for gold: it loves misery, and it loves uncertainty, and there is certainly plenty of that about. It is "a matter of conjecture", points out Brian Durrant, as to whether the re-election of George Bush has made the world a safer place or not, but certainly the problem of Iran - its determination to develop a nuclear capability, coupled with America's determination that it shouldn't - doesn't bode well for 2005. As the threat of military action rises, so will the price of gold, the world's ultimate safe haven.

Gold has also proved an excellent hedge against inflation and hence the debasement of paper currencies. Gold has certainly stood the test of time in a way that no paper currencies yet have. And inflation is becoming more and more of a danger both in the UK and in the US. The last three big flare-ups in inflation have been fuelled by huge rises in the oil price - it happened in 1973, in 1979, and again in 1990. And now oil prices have soared again, rising fourfold since 1998. That's beginning to show up in the numbers. Finally, gold is the perfect hedge against the falling dollar: as the dollar keeps falling (as it surely will), the gold price will keep risin. There isn't enough gold All this means that demand for gold is rising fast. Investors want it, but consumers want it too. Numbers out from the World Gold Council show net consumer demand up 6% in sterling terms and 17% in dollar terms in the third quarter of last year. Demand from the Middle East and China was strong, but the best performances came from India, already the world's largest market, where demand rose 16%, and Japan, where it soared 74% year on year, largely thanks to the popularity of Senryobako treasure boxes - wooden boxes filled with ten kilobars of gold or gold coins. Yet the supply is not there to meet this demand: over the same time period, the World Gold Council notes that supply was "sharply reduced" at 828 tonnes, 22% below the level of supply in the third quarter in 2003. The fact is that more gold is being consume than is mined every year, something that will underpin the price over the long term.

On the way to $3,000 an ounce? The gold price won't rise in a straight line (markets never do), so while everyone should be holding gold in their portfolio - 10% according to Frank Holmes, chief investment officer at Texas-based US Global Investors - they'll need to be prepared for some volatility. Some gold bulls, such as Dan Denning, the editor of Strategic Investment, think that the 16-year highs hit late last year represent a short-term high for the gold price, for example. "In contrarian terms," says Denning, "whenever the crowd is all on the same side of the trade, the trade is nearly over." But what of the long term? "I'm a mega-bull," he says.

So is Christopher Wood. Gold is not really going to start attracting the attention of mainstream investors until it starts appreciating in all currencies, rather than just the dollar, he says on Breakingviews.com. This hasn't really happened yet, but it will. Wood has a bullion price target of $3,400 by the end of this decade. Veteran gold investor Doug Casey isn't far off that. "Sticking my neck out," he told MoneyWeek, "I think we'll see gold prices surpass $3,000 before the decade is over." That would mean a rise of more than 600% in the price of the metal.

One of the best websites for tracking the gold price is www.thebulliondesk.com