Six good reasons you should hold gold

published 31 October 2005

The gold price has risen 44% in the last three years. Despite corrections along the way, gold seems to be at the start of a real bull market. Has the yellow metal's day finally come? Yes, says veteran gold investor Doug Casey.

Over the summer, the gold and silver prices both suffered significant price corrections and, last week, after a nice run up, prices corrected again - along with those of most of other metals. That scared a lot of people. Every time there's a drop, they think the metals bull market is over. I don't think it is. Markets fluctuate more or less randomly in the short run, which helps account for why 95% of futures traders walk away losers. People with such a short time frame shouldn't be in the markets; they should go to casinos. The key is to identify major trends in the markets, understand why they're occurring, and stay with them for as long as possible. Jitterbugs who worry about daily movements will eat their capital up with commissions, taxes and spreads.

I don't have a crystal ball, but I do have a sense of market history. Most of the active players in the last real gold bull market, from August 1971 to January 1980 (which took gold from $35 to over $800), are now dead or retired. Most players today only know of gold as a dog, dropping from over $800 to under $253 in July 1999. Those few who watched the 22-year slide came to see every rally as a selling opportunity. Understandably, people tend to predict the future in light of the past. So they expect bull and bear markets to go on forever. Gold has now moved from $252.80 at the bottom to present levels around $415. But most still see the move as just another rally in a never-ending bear market.

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How do I know they're not right? Well, nobody can be sure. But I've been long on the metal and gold stocks since the late 1990s (I was too early in; generally speaking, only liars buy at the exact bottom), and I'm planning on staying long for the indefinite future. Why am I so bullish? There are six outstanding factors that I believe will almost certainly cause the dollar price of gold to rise.

1. The US foreign trade deficitThe US is currently importing about $500bn more than it exports every year. That's been getting worse for many years, so there are trillions of US dollars now held outside of the US. Since US dollars are only legal tender within the US, whether foreigners continue holding them depends on whether they have confidence in the dollar; confidence can vanish like a pile of feathers during a hurricane. I would suggest that they're becoming increasingly aware that the dollar is, in fact, an "IOU Nothing" on the part of the US Government. And historically, when the dollar falls, the gold price rises.

2. US government deficitsThe US government is also running $500bn domestic deficits. That number is probably already understated, but either way it's likely to go way, way up. Why? It's being financed with some of the lowest interest rates in history, and when rates cyclically rise to more normal levels (remember 15% long rates of the last generation? I expect they will be exceeded), the deficit could reach a trillion. That's not counting greatly diminished tax revenues and the greatly increased government spending that always accompanies a recession - something I think we'll see before too long.

3. The warMy guess is that the adventures in Iraq and Afghanistan are going to get uglier and spread to other parts of the Islamic world. The US isn't going to withdraw but become more involved. This could be a $200bn per year drain, on top of the regular Defense Department and Homeland Security budgets, for many years to come.

4. Supply and demandAlthough most of the gold that's ever been mined is available (either as bullion, coins, or jewellery), the fact is that more is being consumed than is being mined each year by a substantial margin - about 640 tons in 2003 alone. Most of this deficit has been made up by sales and loans from central bank inventory, compounded by forward sales from gold mining companies. The loans and forward sales constitute a short position of substantial size that will have to be covered. And my suspicion is that, at some point in the next few years, central banks will go from being net sellers to net buyers.

5. The real price

When it was trading at $35 in 1971, gold was artificially suppressed in price by government edict. By the time it reached $800 in 1980, it was caught up in a speculative mania. Since then it's achieved some equilibrium. But $400 today is only worth about $75 in 1971 dollars, so it's quite underpriced. And, in real dollars, gold isn't down just 50% from its 1980 peak - it's still down about 85%.

6. Gold as a currency

Take your pick: a piece of paper with less than zero intrinsic value, or a tangible and relatively rare metal that has been viewed as a store of wealth over thousands of years. You want to own gold for all these reasons. But, above all, you want to own it because it's the only financial asset that is not simultaneously someone else's liability - which is why I expect central banks around the world will increasingly be selling dollars and buying gold. It's effectively insurance against everything.

I believe there'll be a gold bull market of historic proportions in the years to come. Retrenchments such as we're seeing now are not only normal, but trivial. You should use them to buy bullion and aggressively add to your mining share positions. Despite strong returns almost across the board in these stocks, there's every reason to believe that when the gold bull really gets under way, these stocks will be wilder than tech stocks were in the late 1990s. And, thanks to the recent correction, the prices on many of the most attractive stocks have fallen back - providing what could be one of the last great opportunities to buy low. Sticking my neck out, I think we'll see gold prices surpass $3,000 before this decade is over. I know that is hard to imagine, but history is littered with sweeping economic dislocations of far greater magnitude.