Where will the gold market go when the perception of low inflation cracks?
On the one hand, there are the gold bugs, for whom the metal is the one true currency. It's been used as money for a few thousand years now, and against that kind of history a couple of months of rising or falling values don't make any difference. To them, no price is ever really high enough. If every other asset is being trashed by wicked central bankers printing paper money, why not just keep on buying? After all, it's bound to be worth more than those brightly colored pieces of paper.
On the other hand, gold's detractors are just as adamant that it isn't worth anything. Like John Maynard Keynes, they regard it as a 'barbarous relic.' Sure, you can make wedding rings from it, but apart from that it's useless. At least with copper you can make pipes, and bonds generate an income. But gold is mainly a psychological asset. It's worth something because other people think it is. There are no reliable yardsticks against which we can measure its value.
The truth is somewhere in the middle. Gold can certainly move into bubble territory, just like any other asset. But its core function is as a safe alternative to cash during periods of prolonged and destructive inflation.
And here's the important point. While plenty of analysts -- including this writer as it happens -- think we are heading for a period of steadily rising prices, that certainly isn't the consensus yet. Just take a look at the government bond markets. The yield on US Treasury bonds is still at record lows. The same is true of most European government bonds, apart from those countries that are already bust. That wouldn't be true if the markets were expecting huge price rises.
In reality, the markets are still priced for low inflation, even deflation. At some point, that consensus is going to crack. Central banks will be forced to raise interest rates -- and potentially quite sharply as they wake up to the fact that inflationary expectations are getting out of hand.
And what will happen then? Bond markets will collapse -- that's certain. Equity markets will wobble. The historical record shows that equities are a poor hedge against rising prices, and they usually do poorly when interest rates are rising.
Where is everyone going to flee for safety? To gold, of course.
As rates start to rise, and fighting inflation becomes the main task of central bankers rather than warding off another great depression, the price of the precious metal will soar.
That will be the blow-out phase of the 12-year bull market.
It might happen next year, or it might be 2013. And gold might hit $2,500 an ounce or $3,000. Or even more.''