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Now that gold has firmly established itself above $1,000 (U.S.) an ounce, the obvious next question is, just how high can it go? The answer might lie in gold's past - and it might not be as high as the gold bugs think.

Given that current prices are at record levels in nominal terms, you'd think there would be no precedent to help define where the "top" for gold would be; after all, we've already pushed beyond all previous tops, right?

Not nearly. When adjusted for inflation, the "real" peak for gold was in early 1980. The peak of about $850 an ounce works out to about $2,300 in 2009 dollars.

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Gold could double and still be below its record highs in real terms. Given that other commodities saw record real prices recently, it's a realistic expectation for gold, the gold bugs suggest (often with drool dribbling from the corners of their mouths). Theoretically? Yes. Realistically? No. The conditions gold faces today are nothing like what it faced in 1980.

1980 vs. 2009 Julian Jessop, chief international economist at London-based Capital Economics Ltd., points out that gold's peak in January, 1980 came at a time of double-digit inflation, the Iran hostage crisis, the Russian invasion of Afghanistan and slumping gold production in South Africa, which then accounted for roughly 70 per cent of world output. In other words, a near-perfect storm for gold prices.

"Of course, gold bugs would argue that the circumstances are similar today. However, the inflation risks are a lot lower, the geopolitical environment … is less uncertain, and gold production is much more diversified," Mr. Jessop wrote.

U.S. consumer prices were down 1.3 per cent year-over-year in September, a drastically different scenario than the 14-per-cent pace of CPI inflation in early 1980, and quite the opposite of what you'd expect to see in a bull market for gold.

And even in those ideal conditions in 1980, gold acted very much like an asset bubble. Mr. Jessop noted that prices, after peaking around $850 in early January, had tumbled to $650 by the end of that month and under $500 by the beginning of April.

WATCH THE GREENBACK So, then, what's been behind gold's run this year? The key culprit has been the sinking U.S. dollar. As the greenback has slid against other major world currencies, gold has risen in lock step. That's not just because gold trades globally in U.S. dollars, but also - and more importantly - because gold is seen as a safe-haven proxy for the currency market, the ultimate alternative reserve currency.

Mr. Jessop argues that gold doesn't look near bubble-level right now - its price is actually near its long-term historical average relative to equity markets and oil prices. But if the U.S. dollar reverses course in the next few months - as many economists predict - gold will probably follow suit.

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"Assuming at least a partial recovery in the dollar in the coming months, we … expect gold prices to fall back below $1,000 an ounce by the end of this year, and as low as $800 during 2010," he said.

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About the Author
Economics Reporter

David Parkinson has been covering business and financial markets since 1990, and has been with The Globe and Mail since 2000. A Calgary native, he received a Southam Fellowship from the University of Toronto in 1999-2000, studying international political economics. More

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