Why gold could hit $5,000 By Anthony Mirhaydari,
MSN Money | 4/21/2011 6:35 PM ET
Fears of inflation and global turmoil have sent precious
metals surging, with gold trading at all-time highs above
$1,500 an ounce. How much further can it climb?
turmoil overseas and energy prices on the rise, investors
are worried. They're worried about geopolitical risk. They're
worried about a falling dollar. And they're worried about
inflation becoming entrenched as the Federal Reserve continues
to administer its cheap-money medicine despite signs of
As a result, gold is on the move again. For much of last
year, gold moved higher over worries about Europe's debt
crisis and a "double dip" recession in the United
States. Prices fell into a funk in the fall, though.
Now, a new set of concerns has gripped the hearts and minds
of investors. Fear has returned.
And the yellow metal keeps hitting new highs, closing on
April 21 at $1,503.80 an ounce.
So how high can it go?
Believe it or not, some analysts are calling for prices
to move close to $5,000 -- not immediately, but sooner than
you may think. Here's why, and a few ways to play gold's
The road to $5,000 gold
This is because, according to the folks at Standard Chartered
Bank, gold is moving into a new "super-cycle"
as a number of structural factors -- including consumer
demand from Asia and tepid growth in supply -- combine to
push prices higher. The team, led by Dan Smith, is looking
for prices of $2,107 an ounce in 2014 as its base forecast.
The team's members see the potential for much more. In
their words, "statistical modeling suggests a possible
'super-bull' scenario of gold prices rallying up to $4,869
in nominal terms by 2020."
It's all about supply and demand.
The driver is increased wealth in Asia. The evidence shows
a strong relationship between rising incomes in places like
China and India and increased gold demand. Much of this
is cultural, with gold holding a place of special religious
Data from the Shanghai Gold Exchange show that China's
gold imports reached 230 tons in the first 10 months of
2010. But in only the first two months of 2011, industry
experts cited by Standard Chartered estimate that imports
hit 220 tons. No doubt, Beijing's somewhat weak-handed efforts
to fight inflation are contributing to the rise, as people
look to protect their burgeoning wealth from the ravages
of rising prices.
David Davis, an old-hand mining engineer in South Africa
who tracks precious metals for SBG Securities, notes that
even poor peasant farmers in India, if the monsoons are
good and the crops are bountiful, will splurge on a grab
of gold. These people may not understand the value of interest-rate
compounding or portfolio diversification, but they know
that gold is an ancient and universally accepted store of
Indeed, the "super-bull" scenario depends on
China and India: This outlook assumes that the average income
per head in China and India reaches 30% of the U.S. level
by 2030 -- up from 2% of the U.S. level in the 1980s and
around 6% now. This seems very likely. Standard Chartered
is looking for India alone to create nearly 500 million
new manufacturing and service jobs over the next 20 years
-- jobs that will expand India's middle class from 10% of
the population today to 90% over the period.
The inflation fight
It won't be a straight shot to $5,000 an ounce, however.
That's because history shows that while gold tends to rally
in the period leading up to an interest-rate hike, it stalls
a couple of months before the actual move higher.
We're in such a period now. The European Central Bank became
the first rich-world monetary authority to tighten policy
last week. In the U.S., the Federal Reserve's $600 billion
"QE2" program to push money into the economy is
set to end in just two months, and near-zero interest rates
appear unlikely to last.
That could result in some volatility for gold over the
next few months as the market waits to see how aggressively
ECB President Jean-Claude Trichet and Fed Chairman Ben Bernanke
attack inflation. Gold, of course, is the traditional hedge
against inflation for investors. And right now, the inflation
threat continues to grow.
"Real" inflation-adjusted interest rates are
negative since inflation is currently running higher than
interest rates. The two-year Treasury yield stands at 0.85%
while consumer price inflation is running at 2.2%. The negative
1.45% real yield is a sign of extremely cheap cash and bubbling
pressure on prices. And it's forcing investors out of cash
and into assets that will hold their purchasing power in
a negative rate environment -- assets such as gold.
Merrill Lynch analysts note that this condition of negative
real rates, as long as it lasts, will be supportive of gold
prices. Bernanke will probably be a softie while Trichet,
due to step down in October, will be more hawkish. So, at
least here at home, negative rates are likely to continue.
Where to find a gold mine?
Also, the short-term picture is clouded by the increased
supply poised to come online. Gold mine output tends to
lag about 10 years behind price peaks, because of the difficult
logistics involved in locating, extracting, processing and
transporting virgin gold. So far, production growth has
been subdued: Mine output expanded 7% in 2009 but only 3%
This tepid growth is actually a big improvement: Davis
notes that between 2001 and 2008, global gold production
declined around 1.3% per year on average. That's changing
now as prices move higher. From his office on the northern
fringes of Johannesburg, Davis told me that there's been
a "moderate uptick" in supply as a number of new
mines -- in increasingly unstable and difficult-to-reach
corners of the world -- have started up over the last 18
A recent survey by consultancy PWC found that 71% of gold-mining
companies planned to spend extra cash on developing new
projects. With cash margins up 40% year-over-year toward
the end of last year, at $655 an ounce according to GFMS
data, Smith believes there is "plenty of money available
to spend, which will help to power the next upswing in mine
investments and projects."
Over the long term, the supply situation tightens again.
Davis is looking for mine production to start dropping at
a 2.5% annual rate starting around 2013 or 2014 "as
global exploration discovery is unlikely to be sufficient
to replace production." He notes that we are already
seeing signs of a "contraction in exploration targets
and exploration efficiency, which, despite an increase in
exploration expenditure, has not kept up with the replacement
of sufficient reserves to maintain mine production."
Just getting the math of global production growth to work
is difficult. It requires not only the continuous replacement
of existing reserves but a steady stream of new discoveries
to boost overall mining output.
The problems are geography and geology.
After peaking in the early 1970s, South African gold production
is dropping off. In 1966, the country produced 78% of the
world's gold. Now, the figure is around 10%. The high-quality
ores that came out of the Witwatersrand and Free State fields
are gone. All that's left is of lower quality and deeper
down, forcing costs higher. New production has moved to
Russia and other former Soviet republics, South America,
China, and the rest of Africa. Not exactly the friendliest
or cheapest places for Western mining companies to work.
Also, engineers just are not finding as many rich new seams
of ore in the Earth's crust. Gold Fields (GFI, news)exploration
manager Tommy McKeith finds that total discoveries have
been in a steady downtrend since 1980, despite a massive
increase in exploration budgets during the same period.
More worrisome has been the huge drop in so-called "green
field" discoveries -- new ore deposits unrelated and
unconnected to existing assets. McKeith comments that, in
his opinion, the industry is not sustaining itself over
the long haul. Reserves are being depleted. New assets are
increasingly being found only in risky parts of the world.
And the ore being discovered is of lower quality than what
All of this is pushing up the cost of production -- which
will act as a hard floor to gold prices going forward and
crimp the availability of supply just as Asian consumers
get heavy pockets. Over the next few years, Davis is looking
for the industry's global all-in costs associated with mining
-- including equipment and exploration expenditures -- to
move toward $1,600 an ounce. And as production drops off
past 2014, costs will only accelerate.
Where is the ceiling?
That brings us back to the big question: How high will gold
For an extreme upside forecast, Société Générale
strategist Dylan Grice notes that if America, out of frustration
with the Fed's failures, were to return to the gold standard
and restore the dollar's convertibility into gold, prices
would surge to nearly $8,000 an ounce. This is the price
at which the U.S. monetary base, which has jumped from around
$800 billion before the financial crisis to more than $2.4
trillion now, would be fully backed by available gold.
We've come a long way. When the Fed was founded in 1913
and policymakers were limited by the dollar's convertibility
into gold, prices were stable at $20.67 an ounce.