It's New Year's!  At the close of one year and the beginning of another, I like to take some time and review what has happened, while looking forward to what will happen.  This article is one in a series of such articles, each examining a different topic.

This one is on gold.

I had a request to put my thoughts together about what I see for gold in the year ahead.

First, the fundamental case:

When you get down to it, gold is money.  I know, I know, people will scream that you can't go into a store and spend it.  Well, the reason for that is because the grand poo-bahs that run the world have done everything in their power to prevent that (so that you have to use their system and allow them to counterfeit more), and they are still failing.  Whatever view you take on whether this is good for the world or bad, you must recognize that people buy gold as a hedge against inflation and government instability.  Gold is correctly seen as a store of wealth that is in your own power to control.  

This function of gold as a store of value is the key to understanding the primary drivers of its market action.  Since I'm in the US and most of you are too, I'll talk about gold's price in terms of dollars.  As dollars become cheaper, whether due to inflation of the money supply or discounting by the world markets, the price of gold in those dollars will rise.  When the dollar gets stronger, the price of gold falls.  This accounts for the majority of the change in price in gold.

The minority of the price change is due to normal supply and demand.  

These two factors, dollar strength and supply/demand, interact and create the price of gold.  So the future of gold boils down to two questions:  1, what will happen to the dollar?  2, what will happen to the supply and demand of gold?

There are those out there who will tell you that the dollar is doomed.  And they are right.  But not today.  There are two major currencies in the world and several minor ones.  The two majors are the dollar and the Euro.  People's attention gets whipsawed back and forth as to which one is dying.  Today it's trillion dollar deficits in the US.  Tomorrow, Spain's government bond offerings get downgraded.  The day after that the US announces a plan to print a trillion more dollars.  And so on.  The problem with all this is that people keep shifting their money back and forth between the Euro and the dollar when these news events are announced.  As long as this continues, the dollar will remain a major (if not the major) currency in the world.  The minor currencies like the yuan, the yen, the Brazilian Real, the Australian dollar, and the Canadian dollar may someday supplant the US dollar.  But not today.  So I see lots of range-bound choppiness for the dollar in the year ahead, and inverse choppiness for gold.

So what do these gyrations do the supply and demand for gold?  Well, supply is pretty steady.  Extracting metal out of the ground is a very intensive process and doesn't change all that fast.  Demand, however, can change drastically.  This instability in the value of the dollar increases demand for gold among those who aren't mentally trapped in the system.  This is bullish for gold.

Overall, the fundamentals point towards a rise in the price of gold for 2011, but there will plenty of retracements and uneasiness in the market.

Next, the technical case:

Unsurprisingly, the chart tells the same story.



As you can see in this weekly chart over the last few years, the trend is up.  There are support levels at 1240, 1200, and 1130.  But we are currently in a narrow trading range in the middle of the channel.  This gives us room to move both up and down, and I expect we will see some of both.  

So again, up overall, but with lots of waves, which will shake out the weak hands who think gold is "too high."

At least, that's the way I see it.

Yep, the dollar is rising and precious metals are falling - although the relative rates show some strength in the metals.

Indeed.  Readers should check my latest post on the silver markets.  It has a quick run-down on the reasons silver is in a long term bull market, and that any retracements should be used as a buying opportunity.