March 01, 2006

NORWALK, Conn. (MarketWatch) -- All eyes are on gold, not Olympic gold, real gold -- with the yellow metal hitting 25-year highs, technical "buy" signals have been going off all over the place.

The questions investors have to ask themselves now are: "Is it too late to buy? And what do I buy?"

It's clear that fundamental forces are lining up to push gold to $600 an ounce very quickly, $640 and well beyond. That makes any short-term pull-back, if there is one, a buying opportunity.

There are many forces driving gold higher, here are a few.

Global metals exploration spending fell sharply to $1.9 billion in 2002 from $5.2 billion in 1997. It's back to an estimated $5.2 billion this year. But the lack of past spending has caused a large exploration and development gap. It can take seven to 10 years to bring a new mine online.

So now is a good time to snatch up the mining stocks that will benefit most from this lag.

Begging to Unpeg

The U.S. and other leading Western industrialized nations are putting pressure on China to de-peg its currency from the dollar.

It may not be such a good idea though. China buys U.S. Treasuries by the fistful to keep its currency pegged -- in fact, U.S. dollar assets account for over three-quarters of Beijing's more-than $818.9 billion in foreign reserves. If

China unpegs its currency, it won't have to buy those Treasuries anymore. China could instead substitute and buy something of real value -- like gold.

The U.S. needs to attract over $2 billion per day in foreign funds to keep the value of the dollar stable. All China has to do is buy fewer U.S. Treasuries and it will start pushing the dollar down faster then Donald Trump can say "you're fired."

And since gold is priced in dollars, as the greenback tumbles, that should send gold much higher.
 

Gold may top a record $873 an ounce during the next three years because the U.S. will be unable to check inflation caused by explosive growth in China and India.

Traditionally, some investors buy gold to hedge against growing inflation. Look at history. Gold futures surged to $873 an ounce in 1980, when U.S. consumer prices gains rose into the double digits, more than 12 % from the previous year.

Everybody thinks inflation is going to stay around 2%. I highly doubt it. Inflation, excluding food and energy, will probably rise 2.4% by the fourth quarter of 2006 from Q4 2005, up from a 2.1 % gain a year earlier, according to a survey by the National Association for Business Economics found.

Gold demand in the Middle East rose 11% in the third quarter of 2005. Now, the U.S. Energy Department forecasts that the oil revenues of the Organization of the Petroleum Exporting Countries (OPEC), which controls 40% of the world's oil supplies, will hit a record $522 billion this year.

That's an increase of 10% -- a new record -- and even adjusted for inflation, that's the highest level in a quarter century! Even if only a small fraction of those funds pour into the gold markets it will cause gold prices to surge.

Iraq is teetering on the edge of civil war and the Iran situation over nuclear weapons grade uranium remains volatile. The combination could send Persian Gulf sheiks rushing into the gold markets to buy more gold.

Worldwide gold production last year had the largest decline in 39 years, according to the World Gold Council said. Demand in India, the world largest consumer, rose 47 % last year, and 14 % in China, the world's fastest growing economy. The decline in output will likely continue for another few years simply because the industry didn't put money back into the ground when the gold price was languishing. And with demand surging everywhere those already established producers will benefit the most.
 

Another investment vehicle is gold futures and options, my personal favorite. For example in three of my portfolios I own June 610 gold calls, I picked them up relatively cheap and even through all the volatility of late they have remained relatively constant. All it would take is an event similar to the recent attempted attack on a Saudi oil facility and gold would take off.
 

If your thing is to hold the actual gold in your hand then numismatics (coins) or bullion are the way to go. Fixed costs associated with these approaches make them unattractive to me as a trader but it's a good way for some.

And lastly ETF's are an easy way for an investor to get involved in the gold market with ease and a bit less volatility then futures.
 

If you are convinced as I am that gold is most certainly moving to the next pricing level, then the only thing to decide is what is the best vehicle to use for the ride there. Gold may be near is highs for this move, but $600 could look like a bargain in a few years if events unfold in this always uncertain world.