How High Can Gold Prices Go During These Times of Market Uncertainty?

The year of 2010 will go down in the history books as a period of financial crisis and uncertainty as markets ponder the direction of future price movements. All eyes have been transfixed on the S&P 500 Index for some indication of what is to come, primarily since most market drivers have settled into direct correlation with the popular index. Gold and the U.S. Dollar, typically inversely correlated, have been dance partners for nearly a year, and have locked on to the S&P 500 index on occasion.

Presently, the stock index has finally broken through its 200-day moving average again, the third time in as many months, but resistance appears to be building as technical indicators signal another overbought condition. Stocks and other correlated market indexes seem to enjoy this sideways motion. Market traders have learned to profit from the predictable swings, but the long-term investor is confused as to where to invest his capital. Invariably, the conclusion reached by many is to invest in Gold where record highs are the norm for this year, as is a continual upward march in bullion values.

Can this trend in Gold prices continue or it just another market aberration brought on by a year of crises and risk-averse capital fleeing to safe havens? For the past decade, Gold has been ramping up in value, unabated by most conditions that have impacted other markets. The recession, whether we are out of it or not, did little to slow down the Gold parade, and its honored status as a “safe haven” has been tested several times in the recent past to no avail. Gold remains impervious to economic data that destroys value on many other fronts.

The following chart provides a longer-term perspective for evaluating present conditions:

This chart suggests that Gold has been in a “recovery” mode for the past decade, making up lost ground on the S&P 500. The price of Gold reached “parity” with the index while the recession was in full bloom and crossed above it in November of last year. Currently, the multiple is 1.12 versus the S&P 500 index, still a bit below the historical average of 1.40. From this perspective, it is easy to argue that Gold has more room to grow

Current Gold prices are due for a slight correction, as buyers and sellers consolidate their positions. Technical indicators, as with the S&P 500, are suggesting that current price levels have run out of momentum, resulting from an overbought status. However, these conditions have occurred four times in the past year, only to be followed by another resurgence in demand.

The surprise for the past year has been that Gold and our greenback have been so tightly entwined together. Traditionally, the two dance partners have been more like oil and water. When one goes down, the other goes up, and vice-versa. The advent of the Euro at the turn of the millennium coincided with Gold’s upward move. As all forex brokers will attest, the “EUR/USD” currency pair bore witness to tradition as the Euro and Gold both strengthened together. That correlation broke down at the beginning of 2010 as concern over debt issues in Europe began to materialize.

If basic correlations have broken down this year, then what are we to believe going forward? A quick review of Gold’s fundamentals may provide the desired insights.

1. Intrinsic Value: Investors the world over appreciate the metal’s ability to retain value and continue to view it as a primary safe haven;
2. Hedge Against Inflation: As recessionary forces wane and recovery plans take hold, interest rates and inflation will surely follow, if only delayed by central bank fears of a return to negative GDP growth. Gold has always been valued as a perfect hedge against inflation;
3. Mining Prospects: Mining interests have had to fight new taxes on their efforts and find new and better extraction methods, but exploration has not suffered, nor discovered any new major deposits;
4. Industrial Usage: Demand is predictable in this area and can only increase as economic recovery spreads;
5. Current Inventories: Despite fear mongering by Gold critics, central banks have no plan or cause to release their stored reserves. Even if they did, China would gladly exchange their U.S. Dollar CDs for Gold today.

While markets and traders alike ponder the uncertainty of economic conditions, the price of Gold continues to set new records and bolster its decade-long upward trend. While technical indicators signal that a slight pullback in price level is in the cards, the fundamental outlook for Gold remains unshaken by the market’s inability to clearly see the way forward. Gold futures on December delivery have shown slight declines, but these are part of the expected correction in price levels.