Who Will Win Gold's Tug of War?

Investors often disagree about the merits of different investments. Few areas inspire more heated debate, however, than gold.

Battling calls on the yellow metal
Recently, a number of analysts have come out with their predictions for where the price of gold will head in the next few years. Merrill Lynch argued yesterday that technical considerations support a move in gold prices to as high as $3,000 by early 2014. Pointing to the second half of gold's more than decade-long uptrend, B of A argues that gold's lackluster performance over the past year has been merely a correction. The big hurdle in its eyes is getting past gold's record highs between $1,900 and $2,000.

Bank of America isn't the only analyst to give a target of nearly $3,000. Deutsche Bank made a similar call from a slightly different perspective, comparing gold's price to those of other assets. Deutsche Bank concluded that current levels of the S&P 500 could support an argument for gold to reach $2,960, although a few alternative calculation methods actually argued for lower gold prices.

Still, sentiment isn't unanimous. Citigroup analysts argued that an improving economy supports a call for gold prices to top out right around current levels. Better economic times will arguably make other investments look more attractive -- especially those that offer income as well as potential for capital gains.

A key factor many ignore
With gold, it's easy to get lost in theoretical discussions. With endless debates on the monetary value of gold, its response to inflationary pressure, and what chart patterns suggest about its future moves, you'll never find consensus.

When confusion reigns, it's easier to get back to basics. Simple supply and demand give some clues about where gold could go, and the picture looks bright. On one hand, costs of gold production have been on the rise for some time. Gold Fields (NYS: GFI) is using $1,500 per ounce as the basis for structuring its business, and Barrick Gold (NYS: ABX) and Goldcorp (NYS: GG) both chose recently to defer new mining projects because of big increases in capital development costs. As more miners make similar decisions in light of rising costs of production, supplies of gold will find themselves under pressure despite the relatively high price of the yellow metal.

On the other side of the coin, demand remains fairly strong, especially from investors seeking to protect themselves from fiat currency devaluation following the Federal Reserve's third round of quantitative easing initiated earlier this month. The ETF SPDR Gold (NYS: GLD) sported more than 1,330 tons of gold as of Tuesday, up from just 1,290 tons less than two weeks before. That kind of buying interest bodes well for gold demand going forward, especially with low interest rates from the Fed making it easy to finance gold purchases without fear of a high opportunity cost from not investing in other assets. Similar interest exists in silver, where iShares Silver Trust (NYS: SLV) filed to give itself capacity to issue as many as 87 million new shares.

Insurance value
Although many investors look to gold as a way to cash in on expected price increases, others are less concerned about making money than they are about protecting against major adverse events. Whether it's the possibility of a eurozone meltdown, a hard landing for the Chinese economy, or a loss of confidence in the U.S. dollar or other major currencies, gold has appeal for those who believe it's the ultimate safe-haven asset.

The reason why there are so many opinions about gold prices, though, is that people have differing views on the likelihood of these cataclysmic events. Gold's big bull run has already priced in at least some value related to the metal's insurance function. If you think there's less chance of a major systemic failure, then you may well think gold is overpriced right now. If you believe failure is more likely than others believe, then buying gold may seem more attractive.

Take a stand
At this point, it's too early to tell which side will win the tug of war over the price of gold. With convincing arguments on both sides, though, you can expect to see both ups and downs persist for a while until a clearer direction becomes apparent.

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The article Who Will Win Gold's Tug of War? originally appeared on Fool.com.

Fool contributor Dan Caplinger likes shiny things. You can follow him on Twitter @DanCaplinger. He doesn't own shares of the companies mentioned in this article. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Fool's disclosure policy is golden.

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