Is Gold Headed For $3,000?

Many experts are saying that gold will reach the $2,000 an ounce level before year's end based on the turmoil and financial crisis in the euro zone. $3,000 gold could become more realistic if contagion spreads from the euro zone to the United States and central banks pump money into the system.

11/14/2011 @ 4:55PM
By Allie Wickman

Gold is seen by most as a safe-haven. If equity markets are in turmoil, "buy gold," we always hear. Gold bulls are currently predicting gold to move over $2000 an ounce by year end. Some of the gold bull’s thesis goes something like this:

Italy, Greece, and eventually Spain will cause a European end-game scenario. The default of bigger European countries will cause the European Central Bank to force money into the system in the form of a massive bailout, mainly being a dovish monetary policy.

The fears of contagion will spread throughout the continent and harm the economic outlook globally, including much harm to the United States. As the crisis unfolds, investors will flock more to gold than the U.S. dollar, as the United States will be in a similar mess. (This is a quick thesis.)

However, Greece should be easier to control than other European nations as its economy is small in relation. Greece’s economy is comparable to that of the state of Indiana, when comparing GDP.

Peter Morici, International Business Professor at the University of Maryland, states that the Greece situation is "unmanageable" saying that, "[e]ven with the haircut for private bondholders, Greece will have a debt to GDP ratio of 120 percent a decade from now, if everything goes right. Virtually no independent economist expects things to go that well and most regard the situation as wholly unmanageable."

That is scary since the size of Greece's economy is not very big. Consider Italy. Its GDP is currently around $2 trillion per year. That is about 7-times larger than Greece's economy. If Greece is "unmanageable", then what is Italy?

This past Wednesday, most Italian bonds traded above the dangerous 7% level, causing a sharp spike lower in equities. One would think that investors would flock to gold, since Italy is a much larger economy than Greece and should cause a much bigger problem. But gold actually closed negative. It was the U.S. dollar that rallied.

So do most investors believe a better flight to safety is in the U.S dollar rather than gold?

That is hard to answer since nothing like this has happened before. The likely answer would be yes, since the European Central Bank has not loosened its monetary policy by pumping more money into the system. When that happens, it is almost certain gold will rise. Until then, Europe remains in a deflationary scenario.

Gold recently tested $1800 an ounce, but has since moved lower to test $1775 or the 61.8% Fibonacci retracement level.

The long-term outlook on gold remains bullish, but the short/mid-term outlook depends on a few factors:

For the fundamental analyst, the future of the precious metal depends on any global-macro factor, mainly being the mess of the Eurozone and if the European Central Bank will loosen its monetary policy.

For the technical analyst, gold's outlook depends on the $1800 level. $1800 was a recent top and obviously a popular psychological level. Gold remains in a Wedge pattern and whichever direction the commodity breaks out of, that is the direction gold will likely continue.

For example, if the precious metal breaks below the short-term uptrend support line around $1780, gold could continue lower and test the 50% Fibonacci retracement level around $1730 and further to the $1700 level. If gold break above the mid-term downtrend resistance level around $1800, the precious metal could continue higher and even eventually test all-time highs of $1923, especially if the crisis in Europe continues to unfold.

The case for $3000 gold is slightly farfetched, at least for now. Contagion would have to continue to spread throughout Europe and spread to the United States. Central banks around the world would have to pump money into the system as global institutions begin to fail. Until then, gold should stay below $2000 an ounce throughout the rest of 2011.

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