Gold at $2,750 an ounce? Here's how it could happen

India, the world's largest consumer of gold, is in the midst of its traditional wedding season, and that always creates extra demand for the pretty much useless yellow metal. Judging by the recent actions of that nation's central bankers, they must have been invited to every instance of nuptials in the entire country.

The Reserve Bank of India purchased almost $7 billion worth of gold from the International Monetary Fund last week, helping to propel prices to $1,100 an ounce. (That's a nominal all-time high, by the way, not a real one. Adjusted for inflation, gold would need to more than double to set a true record.)
Of course, the wedding season has nothing to do with India taking 200 tons of gold of the IMF's hands. More likely, it's the ever-crashing greenback. The U.S. Dollar Index, which measures the buck against a basket of six major currencies, is perilously close to falling through its 52-week low.

There's little wonder why: As long as the Federal Reserve continues to print money with a zero interest-rate policy, it's only wise for other nations to purge rapidly depreciating dollars from their foreign exchange reserves and go gaga for gold. The yellow metal is, after all, the ultimate hedge against inflation.

As much as there's always been something slightly goofy, if not outright kooky, about gold bugs, you've got to hand it to them these days. Gold has soared about 50% in the last 52 weeks, while the dollar has dropped about 15%. The broader market, as measured by the S&P 500 ($INX) is up only 17% over the same period.

Even ever-bearish David Rosenberg is bullish on gold. The chief economist and strategist for Canada's Gluskin Sheff (and formerly of Merrill Lynch) hasn't had much good to say about equities throughout the long, spectacular rally. But he sees glittering things ahead for gold.

"Since the U.S. will not default [on its debt], not raise taxes nor cut spending, the only logical recourse will be to print vast sums of U.S. dollars to fund this surreal foray into deficit finance," Rosie told clients Monday.

Meanwhile, gold production peaked a decade ago, Rosie notes, making the gold trade all about scarcity of supply. To put that in perspective, Rosie laid out three "what if" scenarios and their implications for the yellow metal.

If India were to raise gold's share of its forex reserves from the current 6% to 20% -- or where it was during the strong U.S. dollar policy days just 15 years ago -- gold would hit $1,300 an ounce, Rosie says.

If China were merely to copy India's move and raise gold's position in its forex reserves to 6%, the yellow metal would go to $1,400.

And the third scenario?

It seems far-fetched, but it's certainly the most interesting case. Imagine that rampant inflation forced the U.S. to buy more gold to support its currency. To put our hypothetical gold needs in perspective, Rosie goes back a century to when the Fed -- whose policies are crushing the dollar today -- was first created. Back then the ratio of gold reserves to money supply (using the monetary base) stood at 40%. Today that ratio is 17%.

So here's the kicker: In order to get to that historical 40% ratio from the current 17%, the U.S. would need to purchase three years' supply of gold bullion, according to Rosie's calculations, thus pushing the price up to $2,750.
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