Gold Outlook in 2010

After hitting a multi-year high of above $1200 per ounce in the beginning of December 2009, gold has receded and currently is trading above $1000 in the beginning of 2010. The recent retraction of gold is due to the strength of the dollar which has been buoyed by some positive economic data around housing and the potential turnaround for labor markets in the US. However, many of the larger investment banks as well as industrialized nations seem to agree that gold is either going to stay near current levels or will go higher. For example:

• Morgan Stanley forecast a base price of $1,200 for gold in 2010 with peaks above $1300.
• Macquarie (largest investment bank in Australia) raised their forecast for gold to $1150 per ounce in 2010 (Dec 09)
• Goldman Sachs announced on December 3rd that it has lifted its 12-month gold price outlook to $1350 per ounce from a previous estimate of $950 (Dec 09)
• Merrill Lynch sees gold at $960 an ounce in 2009 as a whole, rising to $1500 in the next 18 months

So the question is why these targets are being set and the reason is quite obvious and has been well publicized. ....the deterioration of the dollar due to excessive dilution of the once favored greenback. This deterioration commenced with hundreds of billions in government bailouts (FRE, FNM, AIG, GMAC etc), continued with stimulus efforts of $800 billion dollars and was capped off by an $871 billion dollar health care reform bill that was recently passed. If you add it all up, we are talking about $15,000 for every household in the US. There is talk of the Federal Reserve eventually hiking rates to curb inflation that may creep up if a recovery takes hold, but it appears that the Fed isn't going to do that at the expense of economic growth. Furthermore US economic growth is highly dependent on job creation, and meaningful job creation isn't on the horizon just yet. It is not just the US that has felt the pain. Finances of governments around the world are under pressure due to expanding deficits and debts. Essentially the credit quality of sovereign debt is deteriorating and is evident with debt downgrades of Spain and Greece as well as troubles around Dubai servicing its massive debt load. History shows us that with these conditions, more and more investors look towards gold as a hedge against their native currency and gets more credence as a universal currency. It looks like that story is playing out again, but we may only be in the first chapter with gold at its current level around $1100.In addition to investors scooping up gold we have for the first time in many years we have governments making significant investments. China purchased 454 tons of gold in late 2009 to boost their total reserves to 1054 tons. Furthermore a high ranking Chinese official, Ji Xiaonan, who chairs the supervisory board for big state-owned companies under the State Council's state assets commission was quoted as saying, "We suggested that China's gold reserves should reach 6,000 tons in the next 3-5 years and perhaps 10,000 tons in 8-10 years," the paper quoted him as saying. Essentially, China is looking at hedging risk by diversifying the almost 2.3 trillion dollars they have in foreign reserves. India also purchased 400 tons of gold late in the year and sovereign nations show no signs of slowing this trend. Below is a recap of the factors that may cause gold to continue rising in 2010:

• Major institutional investment in Gold ETF's in 2010
• China, India and other countries buying large amounts of gold bullion
• US Dollar continuing to lose value due to currency dilution and increase in US debt load
• US Economy continuing to have a weak or inconsistent recovery due to lack of job creation and housing price stabilization
• Debt load of many nations growing putting fiat currencies at risk
• Gold production has been declining since the 1970's

So the case for the continued bullish action in gold prices seems intact, but the market rarely functions exactly as we expect. Lets take a moment to stop drinking the kool-aid and assess the factors that could derail the ongoing gold rally:

• Strengthening Dollar - If the US can quickly curb spending and reducing its national debt, gold could drop back to $800. Realistically, this scenario seems unlikely in 2010.
• Investment interest wanes - If investors suddenly stop investing in Gold ETFs, the price of gold could be hurt. There are some analysts who believe that $100 of the current price of gold is due to speculation
• Gold Supply - If the market is flooded with excess gold due to increased production or vast new reserves being found, it could put downward pressure on gold prices

For the negative factors above however, I cannot imagine that any of the bearish gold scenarios would play out overnight and the bullish scenarios for gold seem much more likely in 2010 and are aligned with the views of the major investment banks like Goldman Sachs (and though some hate to admit it , GS is usually right, look at their earnings relative to their peers during the economic meltdown in 2008). In addition, macro-economic trends take months to unfold and should allow for a gold investor to determine criteria for an exit strategy if they are long gold and feel the tides turning. Having long positions in DGP (Double gold ETF) or GLD with 10% stop losses could be a way to profit on gold in 2010 and limit downside risk. GDX, the gold mining ETF also could yield favorable returns as gold continues to climb.

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