In 2004, the SPDR Gold Trust
Whereas $1,000 per ounce once seemed an ambitious target for gold, bullish investors today believe that the yellow metal is likely to hit the $2,000 mark, with many analysts and investors believing that this could happen in the next year.
I reckon there are three primary factors that could combine to drive up the price of gold toward $2,000 per ounce -- quantitative easing, supply and demand and that most powerful of human emotions: fear.
Historically, low interest rates, high inflation, and expansionary monetary policy (when central banks create new money) have all tended to drive the price of gold higher, as investors seek to protect their savings from devaluation.
Recent years have seen all three of these criteria satisfied and the price of gold has risen by more than 60% in the last three years alone, showing a firm correlation with the U.S. Federal Reserve's first two rounds of quantitative easing (QE).
When the Fed announced its third round of QE on Sept. 13, Fed Chairman Ben Bernanke said that it would continue indefinitely. This factor is possibly the strongest indicator that further gains are likely for gold -- and while the expected QE3 surge in the gold price hasn't materialized yet, it seems very likely that over the next few years, QE3 will help drive gold higher.
In Europe, perhaps the biggest factor supporting the case for $2,000 gold is people's fear that their cash savings will be devalued. The euro could still break up, Greece is likely to have to default on more of its debts, and anything could yet happen in Spain, and perhaps Italy.
The European Union has not yet embraced quantitative easing with the same enthusiasm as the Fed or the Bank of England, but it is committed to low interest rates. In addition, the European Central Bank's new Outright Monetary Transactions program -- under which it will buy the bonds of countries that receive new bailouts -- is said to have no pre-defined spending limits and is effectively QE by the back door.
There is a lot of uncertainty and bad debt sloshing around in the EU, all of which supports the case for gold prices to remain firm or increase toward $2,000 per ounce, as investors seek to protect their savings from devaluation and the risk of debt writedowns.
Supply vs. demand
In addition to inflationary pressures and fear, I believe that old-fashioned supply and demand must also play a role if gold is to breach the $2,000 level. The latest statistics from the World Gold Council's Gold Demand Trends report provide an interesting picture of the global gold market.
Demand for gold falls into four main categories -- in decreasing order of size, these are jewelry (42%), investment (29%), central banks (16%), and industry (11%). Supply falls into two categories, mine production and recycled (second-hand) gold.
So far this year, gold demand for jewelry and industrial use has fallen, as economic weakness and the rising price of gold have dampened markets -- especially the Chinese and Indian jewelry markets, which account for around 20% of total demand.
On the other hand, demand for gold from central banks and investors has risen significantly over the last four quarters, with demand from gold ETFs such as the SPDR Trust, Gold Bullion Securities
ETF demand fell back in Q2 this year, but central banks picked up most of the slack, purchasing 63% more gold than they did during the first quarter of the year.
According to the World Gold Council, the Q2 supply of gold totaled 1,059.1 tonnes, exceeding the total demand of 990 tonnes. However, of this supply, just 706.4 tonnes came from mine production, with the remaining 363.7 tonnes coming from recycled gold.
Supplies of recycled gold have fallen steadily since 2010 and seem likely to fall further, as people either run out of gold to sell or decide to hold on to it a little longer. Mine production is relatively fixed, at least in the short term, suggesting that any increase in overall gold demand could easily create a supply squeeze, driving up gold prices dramatically.
Is it a bubble?
Some investors claim that a gold bubble is forming, and it's true that the price of gold has risen dramatically after a very long period in the doldrums.
In the long term, I expect that the price of gold will fall -- but I believe that a big fall is unlikely until the eurozone crisis is resolved and the U.K., U.S., and EU central banks begin to unwind their QE programs -- in other words, not for a very long time.
Maintaining your gains
Anyone who has invested in the gold ETFs I mention above will have seen some handsome gains over the last few years -- the SPDR Gold Trust has gained almost 120% over the last five years, for example.
However, shares in gold miners have not kept pace with the price of gold in the way you might expect. That situation is now beginning to change and a few high-quality miners now offer the potential for investors to make big gains, as mining shares play catch-up with the gold price.
In a recent special report from the Motley Fool, analyst Charly Travers identified two high-quality mining shares that are likely to outperform the market going forward.
One of these is a specialist gold and silver miner with net cash and lots of room to grow. The company concerned operates in the relatively safe and stable countries of South America and is currently trading well below its 52-week high. If you would like to know more, I would strongly recommend you download your free copy of "Top Sectors for 2012."
This report is completely free and without obligation -- but it won't be available forever and may be withdrawn at any time, so you should act now to avoid missing out.
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Roland Head does not own shares in any of the companies mentioned in this article. The Motley Fool has a disclosure policy. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. Try any of our Foolish newsletter services free for 30 days.
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