On December 3, 2009, gold reached a record high of $1,226.10, as investor fears about the US economy and speculation in the weakness of the dollar grew. Since then the Labor Department released its November jobs report that showed the fewest job cuts since the recession began in December 2007.  The November jobs report showed the economy only lost 11,000 jobs compared to the 125,000 job losses that were expected. As a result of positive indicators in the economy, gold has experienced it’s largest two-day drop during the Dec. 4-5 period since Oct. 2008. This reaction can be expected as investors see signs of a recovery and would like to realize their returns. However, there are still some factors that continue to put upward pressure on the price of gold.

Inflation
Gold has long been viewed as an inflationary hedge and if the increase in global financial liquidity, due to historically low interest rates, begins to take a larger hold we can expect investors to continue to pursue gold as an inflation hedge over the long term.  Gold is likely to remain at high levels until inflationary worries are relaxed. Globally, gold is not necessarily an inflationary hedge as many currencies have appreciated relative to the price per oz. of gold. Some of these countries include South Africa and Australia (recently raised interest rates), which are the number one and number two gold producers, respectively.

Stability
The global gold buying spree also has been brought on by volatility in the marketplace. It has in a sense become the high growth treasury bill. When there are signs of volatility in the market place investors flock to the assets that hold their value over the long term and precious metals, especially gold, has become that asset. In November Paul Mercier, the deputy director general of market operations at the European Central Bank, said at the London Bullion Market Association conference, “…gold is no longer important from a monetary point, but is important as an asset. Gold makes sense as a contributor to risk diversification. Even if some central banks continue to sell and there is a new potential seller with the IMF, I wouldn’t conclude that gold holdings in central banks will decline in the coming years.” Currently, there is a lot of uncertainty in the global environment due to increasing global deficits, a thriftier US consumer, a high unemployment rate and a change in tax policy.

Supply & Demand
Supply & demand conditions will also put upward pressure on gold prices in the near term as production declines and countries such as India or China pursue more gold reserves (recently India bought 200 tons of gold from the IMF).  Mine production is expected to remain low in the near term but pick up again in the medium term as companies successfully ramp up their gold production and rely on more efficient technology, which yields more gold from the mine.  As a greater supply becomes available, gold prices are expected to decline. Returning to the near term, if the recent appetite for gold remains at its current level or increases with another 200-ton purchase of gold from the IMF, gold prices can be expected to rise above their record highs.

The New Normal
Is a surge likely to continue in gold prices?  Or is the market currently experiencing a commodity bubble, which will likely lead to a collapse in prices as the global economy recovers?  There has been speculation of gold reaching the $3,000/oz mark. Recently David Tice, a market strategist at Federated Investors, offered his outlook on the possibility of gold reaching $3,000/oz. His investment thesis is based on an increase in emerging market gold reserves. On CNBC he explained “the emerging markets generating all the free reserves only have 2.2 percent of the reserves in gold, where the developed countries have 38 percent. If [the emerging markets] increase their percent to 5 percentage points, gold could go to $2,000 to $2,500 easily.” He speculates that two years from now gold would reach $3,000/oz as fear will increase and “there will be a global currency disaster ahead”.  The potential for a bursting bubble is also a relevant investment thesis as many see gold as an overbought asset that has increased in value too quickly and is likely to burst as global stability returns to the marketplace and the dollar appreciates. As an investor, it’s important to understand the short-term pressures and the medium to long-term pressures on gold prices. The supply of gold is declining in the near term, interest rates remain low and the global economy continues to see signs of weakness, which could lead to further increases in gold prices. In the medium to long-term we can expect the miners to increase gold production to try and take advantage of high prices, which will in effect increase supply and put downward pressure on the asset.  Currently producers have not been ale to take advantage of the high prices as they have seen a decline in production. In addition, if we see more positive indicators of a global recovery there could be a rapid sell off as investors move quickly back into other areas of the market.