In the next 18 months to two years gold could well rise to around $2,500 to $3,000 an ounce but, such a move is not a cause for celebration.

Ian McAvity, author of the newsletter, Deliberations on World Markets, speaking on Mineweb.com’s Gold Weekly podcast, said that while he is a gold bug, buying gold in the current economic climate is very much like buying life insurance for a short term capital gain, “there is a transaction cost one needs to look at”.

To listen to the whole podcast click here.

McAvity says that he expects gold to head north toward the $3,000 level over the next two years but, says he cannot yet quantify “The magnitude of the crisis that takes it higher”.

“I have very little confidence of what I would call the outcome of quantitative easing as is being pursued by both the US and Europe.  So we’ve got in a sense, the second half of the bear market that started three years ago – we’re only just starting the second half of that now and you might say that the first half of it was arrested by the central bankers bailing things out.  The problem that we’ve got now is the central bankers are wielding a bailing can that has holes in it.  It’s the bailers that have now run out of credibility.”

According to McAvity, currency turbulence and currency credibility and the monetary aspects of gold are its primary drivers at the moment and, in many respects, the current period is very comparable to a couple of periods in the past: 1971 “when the Americans closed the gold window” and 1978 “when there was concerted action by the European Central Banks along with the US to arrest a decline in the US Dollar.”

But, he says the current uptrend is markedly different from that bubble run of the 1970s, “To me this trend of the past decade really dates from the Brown Bottom* of 2000 and in essence it’s been a remarkably orderly uptrend with prolonged corrections and strong advances…If you were to replicate the run of the 1970s in the current environment you’d be talking of something in excess of $5,000 on the gold price and I’m not prepared to go quite that far at this stage. 

“I look at the gold price today being about 50% above the peak that it made in 1980 while the Standard & Poor’s is trading at 10 times its 1980 level and US credit market debt is 12 times the level of 1980.”

Where to look?

According to McAvity, one of the most critical factors for the gold price currently is the return on risk-free capital which is currently negative in real terms.

“As long as the yield on treasury bills is 40 to 50 basis points, then the perceived inflation rate is 200 to 300 basis points – basically holding paper is negative.  And that is one of the strongest underlying features of the gold market and we basically have the central bankers and their quantitative easing load saying that they’re going to try and keep interest rates as close to zero as possible, until they successfully borrow their way out of debt.  The concept of borrowing your way out of debt is I guess, the new math that I haven’t quite grasped yet.

And, he adds, the biggest single question mark at the moment is when the attitude of lenders toward Treasury bills is going to change.

” Americans are delighted to talk about the probable demise of the euro without really thinking through the chaos that the actual demise of the euro might create.  I think that the euro will survive – it’s going through its first really major test at this point but the larger issue is the question of the credibility of the US Dollar when you’ve got just such massive debt burdens lying ahead of them and proposals for deficits that rise as far as the eye can see into the future. 

“It’s the old line of ‘follow the money’ – basically it’s Brazil, india, Russia and China that are the largest external holders of dollars, and for how long are they going to tolerate these American policies.  It was comparable action by the French and the Swiss in 1971 that basically forced the US off of the gold standard and you have to wonder at what point the Chinese particularly, are going to say ‘enough is enough’.

* Brown Bottom relates to when then British Chancellor, Gordon Brown, ordered the selling of over half  of the UK’s gold reserves right at the gold market’s low point.