Gold Headed For Blow-Off Top?

A Globe and Mail report contains Capital Economics' answer to an intriguing question: is gold headed for an all-out bubbleish blow-off top? Capital's answer is, "it might be." Its accompanying forecast is less exuberant than would be expected for a bubble: as high as $1,600 this year and $2,000 sometime next year.

Drawing parallels between now and 1979, although noting that 1980's blow-off top took place with a background of double-digit inflation, Capital's Julian Jessup says that the outlook for gold is on balance more favourable that 1980's.

"The global financial crisis has left serious doubts about the creditworthiness of governments and financial institutions that underwrite paper assets. At the very least, interest rates are likely to remain very low in the advanced economies, thus minimizing the opportunity cost of holding an asset like gold that does not pay any income. We do not expect the major central banks to start to reverse their quantitative easing any time soon either.

"Gold is also now firmly established as a mainstream financial assets, exemplified in the fact that central banks were net buyers in 2010 for the first time in 21 years. The continued rapid growth in emerging economies, including China and India, means that fundamental demand for gold is now stronger too."

Even if the troubles that have raged for weeks in the Middle East ease, Mr. Jessop sees other "economic and financial shocks" that could boost gold, including the fallout from a debt crisis in Japan, the threat of a U.S.-China trade war, and uncertainty over the fate of the embattled euro.

"And even if inflation is unlikely to take off, the havoc that deflation would bring to heavily-indebted economists might prove to be just as supportive for gold."

My own take? There is flammable fuel for an all-out upward fire, but no spark as of yet. I don't see any candidate other than a ramp-up in developed-world inflation. The main barrier to entry into gold has been the opinion that inflation is a non-problem in the U.S. and Europe. The U.S.-as-Japan analogy still lives. A jump in inflation would be the game-changer that would provide the spark - particularly if the Fed and ECB act too late, on the assumption that an inflation flare-up is only anomalous.

How high could gold go if a hot-gas bubble develops? Last time, gold peaked at a price that fully discounted the metal covering all of M1. Using today's figures, and assuming that gold goes that high, $5,000 would be the bubble peak. My own wild guess is $3,000.

That said, a bubble is not a certainty.