Gold is Cheap...

Gold is Cheap,
Yamada, Banks Assert as Sales Pared

By Pham-Duy Nguyen

Dec. 11 (Bloomberg) -- Just because gold is down 14 percent from its high of $732 an ounce on May 12, doesn't mean the rally that began six years ago is coming to an end anytime soon.

The swooning U.S. dollar, which has become a proxy for the slowing American economy and the nation's humiliating lack of success arranging regime change in Iraq, banning weapons of mass destruction in North Korea and Iran and reducing its trade and budget deficits, is making gold Wall Street's darling again for 2007.

``Gold is the purest play against the dollar,'' said Louise Yamada, managing director of Yamada Technical Research Advisors LLC in New York, who sees gold surpassing $730 next year on its way to $3,000 within a decade. Yamada, the former head of technical research at Citigroup Inc., proclaimed gold cheap in 2001 when it fetched $279.

She now has lots of company among the world's biggest financial institutions. Deutsche Bank AG's chief metals economist, Peter Richardson, made gold his favorite pick for 2007. JPMorgan Chase & Co. analysts John Normand and Jon Bergtheil on Dec. 7 said only corn could rival gold as the best bet while Merrill Lynch & Co. analyst Michael Jalonen elevated gold's value through 2010.

``If you can only make one commodity investment,'' gold is the ``choice for 2007,'' said Richardson from his office in Melbourne.

That's partly because five of the past six bear markets for the dollar led to an increase in gold.

Dollar's Slide

The U.S. currency started gasping last February against the Euro and dropped 13.8 percent since then during what has been the worst American housing market in 15 years. On a trade- weighted basis, it has lost 6 percent of its value and is headed for its biggest annual drop since 2004.

Gold, up 22 percent in 2006, is poised for its sixth straight annual gain. The streak is unmatched since 1971 when gold was freed from its peg to the dollar after the U.S. government said it would no longer exchange its currency for the metal.

From the end of World War II, the dollar was fixed at $35 per ounce of gold. In 1934, gold rose to $35 per ounce from $20.67 after passage of the Gold Reserve Act in January that year.

Prices have jumped 131 percent since the end of 2000. The last such rally was in 1979, when gold advanced to $541 from $229 a year earlier and was headed to a record $850 in January 1980.

Breaking Gold Link

To be sure, there are enough skeptics to make the betting on gold controversial.

``It's rare that an asset outperforms others consistently year on year,'' said Andrew Kinsey at Johannesburg-based Craton Capital, whose $267 million precious-metals fund rose 51 percent this year. ``The dollar-gold relationship may break down next year. Geopolitical risks and energy prices could rise to the forefront and impact gold more than the value of the dollar.''

The U.S. dollar will rebound in 2007, said Joe Prendergast, global head of currency strategy at Credit Suisse in London, during a recent radio interview with ``Bloomberg on the Economy with Tom Keene.'' He predicts a 3 percent appreciation for the dollar by December 2007.

Some analysts say the current consensus that predicts no end to the dollar's weakness is wrong. ``The dollar is completely undervalued,'' said Tetsu Emori, chief commodities strategist at Mitsui Bussan Futures Ltd. in Tokyo. ``Metal prices are hitting the tops. This month and next January, base and precious metals prices will go down.''

Gold Rallies

Investors who sell assets denominated in U.S. currency often buy gold. Declines of more than 20 percent for the dollar against six major currencies led to a gold rally of 22 percent from January 1971 to July 1973 and 95 percent from June 1976 to October 1978.

A tumbling dollar caused the metal to rise 40 percent from February 1985 to the end of 1987, 6 percent from June 1989 to September 1992 and 83 percent from July 2001 to December 2004.

Gold's $75 billion market, a fraction of the $2 trillion traded daily in foreign exchange, is getting a lift from widening budget and trade deficits that undermine the dollar. The International Monetary Fund estimates the U.S. current account deficit will expand 9.8 percent to $869.1 billion in 2006.

Tight Supply

``Gold is probably the most straightforward investment to go with in this environment because of its consistent inverse relationship to the dollar,'' said Yamada, voted Wall Street's best technical analyst from 2001 to 2004 in surveys by Institutional Investor magazine. ``Other countries are trying to diversify their dollar holdings. They're buying gold and anything they can to get out of the dollar.''

JPMorgan Chase's Normand and Bergtheil told clients that gold and corn will offer the best opportunities among commodity investments next year because of tight supply and a weakening dollar. The London-based analysts raised their estimate of average gold prices next year by 11 percent to $678 an ounce. Prices in 2008 will average $725 an ounce, they wrote.

``Gold is the only metal, base or precious, which will see no meaningful increase in mining supply next year,'' the analysts wrote, estimating that supply will grow by 1 percent.

Merrill's Jalonen raised his projections for gold in 2008 to $650 an ounce from $600, and 2009 was increased to $625 an ounce from $600. The Toronto-based analyst maintained his 2007 projection for a rally to an average of $675 an ounce ``due to a rebound in gold fabrication demand for bullion, lower central bank sales and continued growth in investment demand.''

Central Bank Sales

Sales of gold by central banks fell 31 percent in the third quarter to 59 metric tons from a year ago, according to the World Gold Council. European Central Bank members this year failed to meet the 500-ton quota for gold sales under the second so-called Central Bank Gold Agreement.

Federal Reserve Chairman Ben S. Bernanke in April told Congress that he looks at gold prices on his computer screen ``every day'' in assessing inflation expectations. Inflation, using the Fed's preferred index that subtracts food and energy from consumer spending, was 2.4 percent for the year ending in October.

``There's information in gold prices as there is in other commodity prices,'' he said. Rising gold prices reflect inflation concern, ``but clearly, a factor in the gold price has got to be global geopolitical uncertainty and the view of some investors that, given what's going on in the world today, that gold is a safe haven investment.''

Gold Outperforms

A slowing economy may force the Federal Reserve to cut interest rates next year for the first time since June 2003, curbing investment in U.S. assets. The Fed has kept its benchmark rate at 5.25 percent since June, while the ECB on Dec. 7 raised rates for a sixth time in a year to 3.5 percent.

Gold has also produced higher returns than the Standard and Poor's 500 Index, up 13 percent this year. The benchmark 10-year U.S. Treasury rose 2.8 percent. The Reuters-Jefferies CRB Commodity Price Index is down 5.4 percent, led by declines in natural gas, sugar, cotton and gasoline.

International purchases of U.S. long-term financial assets have already begun to slow. Investors in September reduced their net holdings of government debt for the first time since February 2003, the Treasury Department said on Nov. 16.

Foreign buying of stocks, notes and bonds declined to a net $65.1 billion after surging to a record $114.4 billion in August. Japan, the largest holder of U.S. Treasury securities, major oil-producing nations and Caribbean investors scaled back their purchases.

Relative Value

Gold remains cheap relative to other assets. The record high of $850 an ounce, reached 26 years ago, is equal to $2,100 in today's dollars after adjusting for inflation. The cost of an ounce today is equal to about 10.3 barrels of oil, compared with 23 barrels in 1980.

``Prices can only go higher from here,'' reaching $800 next year and $1,000 by the time U.S. President George W. Bush leaves office in January 2009, said Frank Holmes, chief executive officer of U.S. Global Investors Inc. in San Antonio. His $875 million World Precious Minerals Fund has gained 58 percent this year. ``Gold is one of my favorite picks for next year, along with platinum and uranium.''

Twelve of 30 traders, investors and analysts surveyed by Bloomberg from Sydney to Chicago on Dec. 7 and Dec. 8 advised buying gold, which fell 3 percent last week in New York to $631 an ounce, the first decline in three weeks. Ten respondents said to sell the metal, and eight were neutral.

Gold futures for February delivery rose $3.80, or 0.6 percent, to $634.80 an ounce on the Comex division of the New York Mercantile Exchange. Prices dropped 3 percent last week.

``A dollar is definitely going to be worth less in one hundred years than it is today,'' said Graham Birch, who helps manage $27 billion at BlackRock Investment Management in London. ``An ounce of gold will still be an ounce of gold.''

To contact the reporters on this story: Pham-Duy Nguyen in Seattle at pnguyen@bloomberg.net

Last Updated: December 11, 2006 14:47 EST