GOLD – As some of you know, I first turned bullish on gold 5 years ago, which was sooner than most people. Of course, that was the time of the amazing “technology revolution”! Back then, gold was considered a “barbaric relic”, which was out of fashion with most investors. After 20 years of dismal returns, the public was convinced that gold was only useful for filling bad teeth! Nobody wanted to hear about gold, let alone own it and there was widespread skepticism towards tangibles.

Since hitting its all-time high in 1980, gold had entered its bear-market and everybody knew of a friend or a cousin who had lost his shirt in gold. In fact, people were so disillusioned with the yellow metal that whenever I spoke positively about gold at investment seminars, most had no problem dismissing my views. In other words, the environment was perfect for the start of a new bull-market! History had taught me that bull-markets were always born amidst despair when nobody was watching. Accordingly, I advised my clients and readers to allocate 15-20% of their net-worth to gold. Some listened, some didn’t but those who did are now sitting on big profits.

Today, the sentiment has reversed and everyone is talking about gold. Suddenly, the metal is back in fashion again and this makes me nervous. On a long-term basis, I have no doubt in my mind that gold will probably go much higher over the coming years. How high? I’m thinking $2,000 or $2,500 an ounce – that’s right, another 400-500% from current levels! However, on a short-term basis, gold is severely overbought and due for a correction, which will provide us with an excellent entry point. So far, the market hasn’t given us a correction but nothing ever goes up in a straight line. For sure, the Iran situation is helping gold’s cause but ultimately the useless “barbaric relic” will correct – markets always do.

I admit that I sold out of our gold and silver mining shares (last month) a bit early, but in this business you take what the market gives you. Being a money-manager, is one of the toughest jobs in the world. If you act, you get the stick, if you don’t, you get told-off for not doing your job! This business is about risk-management and percentages. At present, I still maintain that the risk-reward in gold/silver mining shares is not favourable so I will wait patiently. In any case, I never suggested anyone to sell physical gold bullion and hope none of you did. Remember, physical gold is real money with intrinsic value and all these paper currencies being churned out by central bankers are highly suspect. So, please hang on to your physical bullion!

Figure 1: Gold as a percentage of total reserves by region

Source: UBS WMR, World Gold Council

So, why do I think gold is headed higher over the coming years? There are several reasons but the biggest one is that the public is losing confidence in paper currencies. Rising gold is a clear sign that people are beginning to distrust major world currencies. And can you blame them? The US dollar is extremely weak with America running record-high deficits and debt, Europe can’t seem to agree on anything and Japan’s currency has also fallen sharply. As a result, even some central banks have indicated that they will diversify part of their reserves out of the US dollar into other currencies and possibly gold. Last month’s big announcement came from China and its plans to diversify out of the US dollar. At present, China and Japan own roughly 1% of their foreign exchange reserves in gold, which is miniscule compared to the world average, which comes in at 9% (Figure 1)! So you can see that if Asian banks stop financing America’s current-account deficit and start buying gold (even with a small fraction of their reserves), the yellow metal will go absolutely crazy! China holds 600 tons and Japan 765 tons and these two countries are among the top 10 gold holders. If China moves from its current 1% holding towards the world average (9%), it will have to purchase 4,000 tons, which translates to 2 years of gold-mining production! You can do the calculations, but when that happens, you won’t be able to buy gold around $550 per ounce!

It is interesting to note that according to the World Gold Council (Figure 1), America owns 64% of its own reserves in gold! Also, despite the endless propaganda by its officials, the US is by far the largest owner of gold. Why would America own so much gold if it is so sure of its economy and currency? I leave that to you to decide.

© 2006 Puru Saxena
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