Gold: Still Far to Go

As unrest and regime change threatens a swath of countries across North Africa and the Middle East, gold is reverting to its historic role as the preeminent safe haven but its price is just beginning to reflect the rise in political and economic uncertainty in the region and around the world.

Frankly, given the political prospects for a number of strategic countries across the region, the possibility of long-term uncertainties and the threat to oil supplies, I'm surprised gold has not performed better, especially in light of its own bullish market fundamentals.

Inflation Pressures: Global food and commodity prices have been on the rise for the past year, consumer price inflation has been unacceptably high China, India and other emerging economies. . .and signs of rising inflation are beginning to appear in the United States.

U.S. Monetary Policy: Years of reflationary monetary policies in the United States—and the financing of America's federal budget deficit with newly minted money, euphemistically called "quantitative easing" by our central bankers—has, in effect, underwritten higher commodity prices and made the coming acceleration in U.S. inflation inevitable.

Oil Prices: Higher oil and gasoline prices—partly a consequence of Mideast unrest and partly a consequence of the Fed's dollar-debasing policies—are just now beginning to trigger more widespread price pressures across the global economy. Global economic activity will suffer as higher prices like a tax paid to oil producers, rather than the U.S. Treasury, erode consumer purchasing power and restrain business investment.

Faced with stagflation, America's central bankers may talk tough about inflation but will continue their stimulative policies to both promote employment and reduce the burden of outstanding private- and public-sector debt by currency debasement.

Bullish Fundamentals: Even without North African-Mideast turmoil and higher oil prices, gold's own bullish market fundamentals should be enough to push the yellow metal's price significantly higher this year and beyond.

Most importantly, gold will also benefit from unfettered Asian buying and central bank reserve accumulation. Both are sustainable long-term trends that not only bid up current prices. . .but also put gold in strong hands that will hold it for years, if not generations.

Global Market: Gold investors and traders, sitting in their homes and offices here the United States may think the day-to-day fluctuations, as well as the long-term trend in the metal's price, reflect the wiggles in U.S. interest rates, the Federal budget debate raging in Washington or the latest news on Wall Street.

But what also matters as much, if not more, is the seemingly insatiable appetite for gold in China, India, and across much of Asia where many gold investors and jewelry consumers are ignorant of economic developments here in the United States but are buying because that is what they do when their own incomes are growing or their home country's domestic inflation rates are worrisome.

Central Banks: After two decades of net central bank sales, the official sector has also become an important long-term buyer in the past couple of years. Much of the buying of late has come from China and Russia, both of which buy from domestic gold production, thereby denying supply from the world market. And, possibly one or more of the reserve rich oil-exporting countries have also bought gold in light of popular unrest in their own neighborhood or simply to diversify reserve holdings and reduce dependence on the U.S. dollar.

In fact, all of the central banks that have bought gold in recent years - a list that includes not only China, Russia, and Saudi Arabia but India, Sri Lanka, Bangladesh, the Philippines, Thailand, and others - today remain underweighted in gold. All still hold the lion's share of their official reserves in U.S. dollar securities. . .and all have an incentive to accumulate gold on price declines. By doing so, they limit the downside risk to private gold investors and speculators.

Higher Prices Ahead: So far, there's been no panic rush by investors into gold and silver. . .and the markets show no signs of a blowoff or irrational bubble.

Investor participation, both retail and institutional, in physical and futures markets, though growing, remains low. As investor participation continues to grow—as gold and silver go more mainstream—there will be more funds chasing a limited number of ounces. . .or tons of metal. Unlike dollars, euros or yuan, central bankers can't just print more of it.

The uncertain geopolitical outlook and impact of higher oil prices, along with gold's very bullish supply/demand fundamentals and growing investor participation, suggest the yellow metal's price could easily reach the vicinity of $1,700 an ounce by late this year—that's about a 19% increase from recent prices—with $2,000 gold likely in 2012 and still much-higher prices in subsequent years.

Gold: Still Far to Go