Byline: Emily Flynn Vencat
There is no bull quite like a gold bull these days. After a roller-coaster week, gold closed Friday at $658 an ounce, down sharply from the 26-year high of $730 set the week before. Predictably, the market has started to murmur "bubble," but the bulls are unfazed. Many forecast gold topping $1,000 an ounce, and private predictions go as high as $15,000. Michael Lynch-Bell, head of mining and metals at Ernst & Young, says the potential is virtually limitless: "In the 1970s, oil projections just went up and up to the $100 a barrel level. People thought it was ridiculous, but just look where we are today. Gold reaching the thousands is only as absurd as that."
The bullish case goes well beyond the familiar image of gold as a haven in uncertain times. Demand has shot up for gold both as jewelry, due to exploding wealth in the nations of Asia and the Middle East, and as an investment, due to the rise of funds that make it easy for individuals to trade in gold. Combine this with the fact that global output of gold has been falling, despite the price boom, and you can see the makings of a fundamental shift in prices. In a new report Goldman Sachs argues that this is exactly what has happened, quite suddenly. "The equilibrium price of gold was $350 an ounce for the last 20 years," says Jeffrey Currie, head of commodities research at Goldman. "Six weeks ago, gold repriced itself at an equilibrium value of almost twice that--$650 an ounce."
How does that happen? Gold is an atypical commodity, in that it has few practical uses (unlike oil, say) is rarely consumed (except for a few industrial applications) and therefore raises no fears of scarcity, a factor critical to the price of other commodities. Mined gold stays in circulation, mostly in the form of jewelry. So gold is seen more as a store of value--a form of currency--than as a precious metal like copper or tin. Indeed for many years, Goldman's charts show, gold mirrored the dollar, floating around that equilibrium price of $350 in a close, inverse relationship with movements of the greenback. Since the dollar was strong and stable, gold was weak and stable.
Then came the tectonic shift. In late 2005, as the demand pressures cited above began to gather, the link was broken: gold began to rise much more rapidly than the dollar fell, coming back into line only a few weeks ago, but at a higher equilibrium price of about $650. Goldman expects the new equilibrium to drift upward to $800 before …