Gold has done everything investors could have asked for over the last 12 months. As financial markets collapsed, gold kept its value and proved its worth as a safe haven. Now it is on another roll. It came close to breaching the magic level of US$1,000 an ounce once again last week, and the record nominal high of US$1,033 an ounce is also in sight. Will it keep going up or is the end of the bull market in sight? A gold bear and a gold bull offer their views.
THE BULL
JOHN EMBRY
Sprott Asset Management
John Embry says investors should buy gold for one obvious reason: It always does well when it re-establishes itself as a currency. Clearly, that is happening right now as the U. S. dollar and other currencies look more dubious by the day, and gold emerges as the logical safe haven.
"It's not gold that has changed, it's the value of paper money," he says.
"Relative to the overall financial sphere, gold is a small asset class. So it doesn't take a lot of money moving in its direction out of paper to have an outsized impact."
Mr. Embry, chief investment strategist at Sprott Asset Management and one of the world's most outspoken gold bugs, has been active in the bullion market since the 1970s and has gotten progressively more bullish in recent years.
His arguments are straightforward: Central banks are printing trillions of dollars, many of which are bailing out failed financial institutions. The logical results are currency debasement and extreme inflation. The former is already happening; he figures the latter is just around the corner, and will be like "nothing we've ever seen before."
In a hyper-inflationary environment, investors will continue to pour money into stores of value like gold, he says, more than offsetting any declines in physical demand for the metal.
Add in the fact that mine production has steadily declined over the past few years, and you have more investor dollars chasing fewer available ounces of gold. The result can only be higher prices.
"I think US$1,500 [an ounce] is certainly achievable in the next 12 to 18 months. Beyond that, who knows," he says.
Another bullish signal he loves to talk about is the central banks. Mr. Embry firmly believes Western central banks have clandestinely dumped gold on the market for years to keep the price suppressed, and their holdings are now far lower than they let on. (He thinks they may have less than a third of the 31,000 tonnes they claim.) At the same time, Eastern powers such as China cannot be happy with all the U. S. dollars they are holding in their central banks, and it only makes sense for them to diversify their reserves by buying gold.
THE BEAR
PAUL WALKER
GFMS Ltd.
Paul Walker is not trying to dispute the argument that gold prices could go up significantly. He is simply trying to show that there is major downside risk as well.
Mr. Walker, chief executive of London-based gold consultancy GFMS Ltd., points out that this gold bull market is being driven entirely by investment demand. Actual physical demand for gold, be it for jewellery or anything else, has fallen off a cliff because of rising prices. Mine production may be in decline, but it is still in excess of the physical demand for gold.
"The question then revolves around how much investment demand do we have, how strong is it, and what happens to the gold market when investment demand goes from strongly positive to neutral or negative," he says.
Mr. Walker lays out a couple of scenarios. Under one of them, the economy gets worse, new toxic financial assets emerge that nobody knows about and inflation runs out of control. If that happens, he has no problem seeing a gold price of US$1,200 an ounce or higher.
But what if the opposite happens? What if economic growth picks up, General Motors is successfully restructured, bank balance sheets are cleaned up and inflation is held in check by higher interest rates?
To him, the thesis for holding gold as an investment can vanish very quickly in that environment. And that's where things get scary, because prices may have to fall a long way before the physical demand for bullion comes back.
"We're on the cusp of these two very different scenarios. We've got an inflection point that's going to take us one way or the other, in my view. And I have to be intellectually honest and say that I don't know which one it is going to be."
But his gut is telling him that gold prices will peak over the next three to six months, followed by an end-game in which the investment case for gold "dissipates very rapidly."
In a broader sense, Mr. Walker says that unless you can make a reasonable case for investment demand to drive gold prices "in perpetuity," eventually there will have to be a correction in prices to bring the market back into equilibrium.
