How much further can gold climb?

Some commentators have suggested that the average gold price could be as high as $725/oz this year. John Stepek explains why holding gold continues to be a wise strategy.

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As most MoneyWeek readers will be well aware, Gordon Brown's decision to sell half of the UK's gold reserves in a badly-handled auction in 1999, and put the money into paper currencies including euros and the dollar, was a costly mistake for the British taxpayer.

Accountancy group Grant Thornton puts the overall cost (for now) at around £2bn, reports The Sunday Times. "The 17 auctions achieved prices for the gold of between $256 and $296 an ounce, with an average of $275." This period is now nicknamed the "Brown bottom" by dealers - the situation was made far worse by the way the Treasury loudly announced the sale of the gold in advance, driving down the price further.

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Since then, of course, gold prices have soared to well over $600 an ounce. But according to the paper, the Chancellor took no advice prior to the sale on what the long-term trend for gold might be. This isn't much of a surprise - Stalin wasn't terribly interested in other people's opinions either.

But a more pressing question is, having come so far, is gold still worth buying?

Gold has risen from an average price of $271 an ounce in 2001 to an average of $673 last year.

But Martin Spring in his On Target newsletter reckons that gold could post a similarly strong performance in the years to come, rising to more than $1,500 an ounce in the next few years - which would still be no higher than its previous 1980 peak (adjusted for inflation) of around $850 an ounce.

Independent metals research group GFMS reckons we could see an average of $725 in the second half of this year, and $850 next. Central banks are becoming less keen to sell as the price ticks ever higher, while many nations with massive paper currency reserves, reportedly including China and Russia, are trying to increase their gold reserves.

GFMS is upbeat on the gold price for various reasons - the fragile dollar and ongoing geopolitical tensions are just two key reasons. But one point which Spring makes is that investment demand, at $14bn, is still tiny in relative terms.

"There is clearly huge upside potential should big money decide to move into it [gold] for any reason. Even without any particular trigger, we have long-term investors such as pension funds raising their stake in commodities generally, giving gold a rise up with all the others."

He reckons everyone should hold about 10% of their portfolio in gold, which sounds reasonable to us. You can find out more about how to invest in gold on the MoneyWeek website - just click here: Investing in gold.

Even Alan Greenspan - the interest-rate maestro and pin-up of those who believe we are now in a new era' - is a passionate believer in the wealth-protecting powers of gold. This is the man for whom every economic problem could be solved, it seemed, simply by cranking up the printing presses.

The Sunday Times quotes Greenspans reaction to the UKs decision to sell gold. In May 1999, he said: "Gold still represents the ultimate form of payment in the world Germany in 1944 could buy materials during the war only with gold. Fiat money in extremis is accepted by nobody. Gold is always accepted."

Mr Greenspan has always had a love for gold - in fact, one of his early essays on the subject, from 1966 (you can read it in full by clicking here: Greenspan on gold) pretty much summarises every good reason for having at least some exposure to the yellow metal in your portfolio.

The Maestro's elegant defence of what central bankers of his ilk would more normally describe as a barbaric relic' has occasionally lead us to wonder about his motives for dropping interest rates so sharply.

Maybe Mr Greenspan hoped he could engineer a return to the gold standard by choking the global economy on paper money. If that was the case, he may yet get his wish. As Capital Economics's Roger Bootle points out in The Telegraph this morning, despite the slowing US economy, core inflation in the US is running at around 2.7%, compared to the Fed's comfort zone' of around 2%.

That will make it far harder for investors to rely on a Bernanke put' just as they relied on the Greenspan put' to bail them out when hard times loomed. And that's just another good reason to keep holding onto gold.

Turning to the stock markets

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In London, the FTSE 100 index of leading shares achieved its highest close since September 2000 on Friday, gaining 46 points to end the day at 6,462. Pharma stocks AstraZeneca and GlaxoSmithKline made the day's greatest gains following upwardly-revised guidance from US peer, Merck. Oil stocks BP and Royal Dutch Shell put in a strong performance as well. For a full market report, see: London market close

Elsewhere in Europe, the Paris CAC-40 also hit its highest close since Autumn 2000, 5,789, having added 40 points as likes of Peugeot and Sanofi Aventis made strong gains. In Frankfurt, SAP and BASF led the DAX-30 index higher to a close of 7,212, a 69-point gain.

Across the Atlantic, US stocks closed higher as the major indices were boosted by encouraging earnings and updates from Merck, General Electric and McDonald's. The Dow Jones added 59 points to close at 12,612. The tech-heavy Nasdaq gained 11 points to end the day at 2,491. And the broader S&P 500 closed 5 points firmer, at 1,452.

In Asia, the weaker yen helped exporters such as Canon and Honda, taking the Nikkei 225 264 points higher, to 17,628. In Hong Kong, the Hang Seng added 276 points to 20,169.

Crude oil was 16c higher, at $63.79, this morning. In London, Brent spot was at $68.79 a barrel.

Spot gold was up to $687.20 this morning, from $684.30 in New York late last night. Silver, meanwhile, was $14.04.

And in Amsterdam this morning, ABN Amro published its earnings 10 days early as Barclays and Royal Bank of Scotland compete to buy the Dutch bank in the largest takeover battle ever seen in the financial services sector. The in-line results showed a 31% rise in first-quarter profit partly attributable to the sale of its US mortgage arm.

And our two recommended articles for today...

Have central bankers lost control

- Around the world, central bankers have been raising short-term interest rates seemingly to no avail. Equity prices still continue to surge and M&A activity is at record levels. To find out what's going on - and how it's all likely to end - read: Have central bankers lost control?

Why equity markets are due a correction

- We are now in the second longest period the Dow Jones has gone without suffering at least a 10% correction. How long before it hits - and how severe is it likely to be? Click here to find out what the key market commentators and the major market indicators suggest: Why equity markets are due a correction

John Stepek

John is the executive editor of MoneyWeek and writes our daily investment email, Money Morning. John graduated from Strathclyde University with a degree in psychology in 1996 and has always been fascinated by the gap between the way the market works in theory and the way it works in practice, and by how our deep-rooted instincts work against our best interests as investors.

He started out in journalism by writing articles about the specific business challenges facing family firms. In 2003, he took a job on the finance desk of Teletext, where he spent two years covering the markets and breaking financial news. John joined MoneyWeek in 2005.

His work has been published in Families in Business, Shares magazine, Spear's Magazine, The Sunday Times, and The Spectator among others. He has also appeared as an expert commentator on BBC Radio 4's Today programme, BBC Radio Scotland, Newsnight, Daily Politics and Bloomberg. His first book, on contrarian investing, The Sceptical Investor, was released in March 2019. You can follow John on Twitter at @john_stepek.