Attempt At A Forecast

I can't claim to have any expertise in the field. This attempt to forecast what gold will do this coming year will be based on little more than a reading of long-term charts and my own sense of where the U.S. and other economies are headed this year.

First of all, gold is still in a bull market. The credit crunch, and the resultant demand for greenback and U.S. Treasury securities, hit gold hard in mid-2008. That low, however, was close to the 2006 high. There has been no long-term trend of lower highs and lower lows in gold. Last year, after the credit crunch had passed, gold soared to a new all-time high. The US$1,000/oz barrier that had stymied since March 2008 was broken in September '09.

The only scenario that would turn the gold bull into a bear would be a zero-inflation economy long-term. Too many central banks have bent too far for too long for this outcome to be plausible. Now that deflation (if it was that) has turned back into inflation, the price of getting the economy out of the credit crunch is going to be felt - and that price is inflation. I believe there's a simple political calculus at work: inflation can be reversed, as was done in the early 1980s. Although a high-inflation low-growth economy does bring widespread discontent, it's much less unpalatable than the alternative: a deflationary debt implosion. If there's a choice between over-reflating and risking the badge of infamy, there'll be over-reflation. That's what we're beginning to see now.

It's important to remember that the market constraints against overinflating have eroded. The "bond vigilantes" are gone. Rather than being seen as "certificates of guaranteed confiscation," Treasuries are widely seen as a safe haven. Too many bondholders don't mind locking in at a negative real rate, and they're lulled by a near-thirty-year bull market in bonds. The bond vigilantes arose in the 1970s, and flexed their muscles in the 1980s. At the time they arose, U.S. Treasuries has been in a bear market since 1949. Bond market conditions today are profoundly different.

A similar calculus applies to the much-storied foreign holders of U.S. Treasuries, particularly the PRC government. The present moves in to gold, both by the PRC government and the Chinese public, are likely diversification moves combined with the hope that the renminbi can be built up to be a world-class currency in its own right. The renminbi is still tied to the U.S. dollar; as an export nation, the PRC tends to benefit when its currency falls. U.S. dollar devaluation devalues the renminbi along with it, helping PRC exports. I'm not claiming that the PRC monetary officals will be pussycats with respect to U.S. inflation and greenback devaluation, but I am claiming that some of their priorities are in line with U.S. devaluation through inflation. A similar calculus applies to the second-largest foreign holder of U.S. Treasuries, the government of Japan.

For these reasons, I conclude that there are no imposing market barriers to over-reflation. However, it'll take some time to work through the system. Excited gold bulls think the over-reflation, and the long-term effect of the U.S. Treasury debt ballon, will be discounted in the gold price right now. I don't think they will. In my opinion, gold has little reason to move upwards until the inflationary effects kick in.


The following two charts are of 5-year and 10-year gold, as of the day of this post:






I don't think the gold price will sink like it did the last time, because a new credit crunch is quite unlikely. However, there are similarities between the current pullback and the one in the spring of '06. Gold got ahead of itself back then, and took more than a year to surpass the '06 high of about $720. What got gold rolling to newer highs in '07 was the pick-up in inflation, but the early '06 market overdiscounted it - went too far, too fast for the time.

We're in a similar situation now. The emerging-economy central-bank purchases were too vaunted, and it was forgotten that those purchases only make sense when done prudently. $1,050-$1,100 was prudent in retrospect. Buying at $1,200 would not have been.

There's no real reason for gold to go down, as explained above, but there's no real reason for gold to go up right now. There would have to be a real inflation and/or devaluation shock to get gold shooting up. I don't see either on the near-term horizon. If anything, the greenback's chart indicates a reversal of last year's plummet.

Thus, I'm predicting that gold will spend 2010 in a trading range, between $1,050 and $1,200. Any sustained move above $1,200 will be prefaced by a few tests of that level.