While Gold Prices Will Move Higher

According to a recently released report from the World Gold Council, overall demand for gold jumped 16.3% in 2005 from 2004. But, if we look closer at the report we find the jewel of information we have been looking for.

Last year, growth in investment demand for gold significantly outpaced demand for gold used to make jeweler. In particular, investment in gold Exchange Traded Funds (ETF) jumped 53% last year. In 1995, investors aggressively bought ETFs and gold- backed securities for investment purposes.

While jewelry makers have traditionally been the biggest users of gold (especially in China and India), the investment demand for the yellow metal obviously had a substantial impact on total demand last year, pushing the price of gold to new 25-year price high.

With gold prices jumping in the fourth quarter of 2005 so aggressively, jeweler demand eased. It may take sometime for consumers to adjust to the higher price of jewelry because of gold’s price rise, but I have news for consumers. Gold prices are only now just getting warmed-up.

After a huge price run-up, the price of gold has been stuck in the $550 U.S. and ounce range for some weeks. I believe this to be a normal rest after such a strong price run-up. It will take time for consumers to adjust to higher jewelry prices because of higher gold prices, but they will (just like consumers adjusted to rising diamond prices).

It’s the investment demand for gold that will eventually push prices much higher. As I wrote Thursday, although interest rates have risen aggressively in the U.S. over the past 18 months, the U.S. dollar has all but just held it’s own as opposed to rising in price against other world currencies.

If the U.S. stops raising interest rates, there will be added downward pressure on the U.S. dollar and investors will be out again looking for an alternative source of wealth, such as gold bullion. While I would not be surprised to see gold bullion prices correct to as low as $475 U.S. an ounce after such a strong price run-up, the upside for gold could be huge if foreigners get nervous amount the U.S. dollar.

You need to ask yourself two important questions: Will the U.S. raise interest rates much further and risk a domestic recession? Will (or should I say can) the U.S. start reducing the deficit anytime soon? If your answer to these questions is no, you should be looking to gold as a serious investment.