Gold could break the $1,500/oz barrier within five years
Ovid Abrams

The current bull market for gold could last another five years, if certain conditions are in place, and the metal's price could soar to an incredible $1,500/oz, according to David Rosenberg, an economist with Merrill Lynch. He suggested that investors buy gold to beat the current period of stagflation.

"Although hardly out of control, the reality is that inflation concerns are starting to show up again in the fixed-income market," said Rosenberg in the current issue of Merril's Portfolio Manager's Review. "We have seen these intermittent stagflation fears surface no fewer than three times in the past three years, and we found that in these episodes where the yield curve is steepening at the same time that TIPS (treasury inflation-protected securities) break-evens are widening, the best-performing S&P sectors were energy, materials and industrials."

"An asset that fares well in such periods is gold, which has already rallied 6% since the latest run-up in oil, the widening in TIPS spreads and steepening curve took hold simultaneously," said Rosenberg. "We reiterate that gold is in a secular, not merely cyclical, bull market. Indeed, gold formed a very similar bottom formation in 1999 as the S&P 500 did back in 1982."

Rosenberg continued: "If this [scenario] plays out like other secular bull markets have in the past -- emerging markets, bonds, stocks, oil, real estate -- then this is a run that can be expected to last at least another five years and ultimately see bullion break the $1,500/oz barrier." He has described gold as a "very successful hedge against deflation and inflation fears." Rosenberg noted that although that view may raise eyebrows, "gold has already more than doubled this cycle to levels that few were calling for five, six or even seven years ago." He added that if gold had merely kept pace with inflation during the past 25 years, the nominal price would have already cleared that $1,500/oz threshold.

"As we have already seen so far this cycle, gold has proven to be a very successful hedge against deflation ... and inflation fears (which is one reason why it is in a secular bull market)," said Rosenberg. "If gold's secular bull market plays out like other secular bull markets, expect this run to last for at least another five years (trough-to-peak % change) We reiterate that gold is in a secular, not merely cyclical, bull market. If gold had merely kept pace with inflation during the past 25 years, the nominal price would have already cleared that $1,500/oz threshold."

According to his analysis, other forms of investment have outperformed gold from their recent lows to their peaks. For example, the S&P 500 gained 1,366% from July 1982 to August 2000; NASDAQ gained 1,324% from October 1990 to February 2000; and the Home Building Index rose 954% from February 2000 to July 2005.

Rosenberg cited various economic issues for his support for gold. Touching on the rebirth of inflation expectations, Rosenberg said: "Even as we focus intensely on the implications of the escalating housing recession -- new home sales at seven-year lows, inventories at 16-year highs, Case-Shiller home prices down in each of the past six months and in 80% of the country (looking at 20 metro areas), and home building stocks sliding over 25% since the peak in February and sub prime mortgage problems, another development has surfaced that has near-term market implications at least. That development is the resurrection of inflation expectations.

He noted that recent news that Congress would impose fresh tariffs on China is "likely to add fuel to this flame." Adding to this is the implications for crude oil prices if the tension between Iran and the West should prevail.

"Also, investors should keep in mind that the 0.3% rise in the core PCE deflator took the year-over-year rate up to 2.4%, challenging a 12-year high," Rosenberg said. "We are not rampant inflationist, and much of the recent above-expected core figure reflected another outsized increase in medical prices. But it is what it is, and unfortunately core inflation is moving away from our forecast and, more importantly, away from the Fed's comfort zone."

Rising core inflation means that the hurdle for the Fed to ease policy in the face of a weaker economic and/or financial backdrop is higher than what we had previously thought, he pointed out.

"Since the middle of January, we have seen oil go from around $50/bbl to $65/bbl (as an aside, as gasoline breaks $2.60 a gallon, it represents about a $45 billion drain on consumer cash flow, or the equivalent of a 0.5% pay cut for the average American worker)," Rosenberg added. "This has helped lift the CRB index by over 11%."

Ovid Abrams; ovid_abrams@platts.com

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