For gold bugs, the sharp climb is vindication. During much of the '90s, the dollar and Treasury securities posted superior returns, as central banks worldwide dumped the mineral in exchange for those assets. Gold fans saw only short-lived spikes. In 1999, investors bid gold above $325 on the prospect of more orderly selling by central bankers, but that price proved unsustainable as the dollar continued to rise.
This time, the increase could be more lasting as forces push the dollar lower. The Bush Administration may end this fiscal year with a $100 billion-plus deficit. That and concerns about the economic recovery's sustainability have helped drive the dollar down 7% against other major currencies since January. "The dollar has entered a long-term bear market," argues Donald G. Coxe, chairman and chief strategist of $17 billion Harris Investment Management in Chicago. His prediction: Gold could hit $350 this year.
Inflation signs are also driving gold prices. Consumer prices have already climbed at an annualized rate of 3.8% in the first four months, up from a 3.5% rate in the year-ago period. Gold bugs fear the rate could rise higher if the Federal Reserve continues to spur the economy with low interest rates. Investors are apt to turn to gold when they can't make gains on short-term investments such as Treasury bills, after adjusting for inflation, says Northern Trust Chief Economist Paul L. Kasriel.
Indeed, investors may have few other choices. Equities markets worldwide are drifting sideways. Japanese investors, facing deflation at home and currency losses on U.S. investments, are flocking to gold. "We might be reverting back to some level of interest in hard assets rather than paper assets," says J.P. Morgan Securities analyst John Bridges.
Increasing political instability may also be playing a role. Some hoarding is being reported in the heavy gold-consuming nations of India and Pakistan, where leaders are threatening war. Terrorism in the Middle East and in the U.S. is far from contained. And talk of a U.S.-led war against Iraq adds to uncertainty.
Moreover, new production of gold is down, putting a crimp on supplies. "There are very few new mines to build because the level of exploration spending has been so low for the past five years," says Randall Oliphant, CEO of one of the world's biggest miners, Toronto-based Barrick Gold Corp.
Still, there are forces that could limit gold's climb. It performs best when inflation is a serious worry, but most economists believe the Fed will keep prices firmly under control. And if U.S. growth continues to surprise on the upside, as in the first quarter, that could bolster the dollar. One thing seems certain: Gold won't get near the heights of 1980 anytime soon, when global instability and stagflation pushed the price to $850 an ounce. But for investors who bought at gold's recent low, there may still be plenty of room to run. By Joseph Weber in Chicago