We continue to believe that gold will hit $700 this year and the historical peak at $850 will be surpassed. This bull is just getting started.

Gold and gold stocks have climbed the proverbial wall of worry. Despite a recent pullback, the underlying drivers remain intact - an overvalued and declining dollar, chronic US twin deficits, rising interest rates, tight supply, increased protectionism, geopolitical tensions and the lack of faith in currencies.

Gold is money, it cannot be created and is very expensive to mine; it cannot be printed like fiat currency. Gold, as we said the past, is the chicken little of the financial markets. Gold has been a better investment than equities and even cash last year. Gold's rise is due to its alternative to currencies.

Recently Asian central banks and investors have been buying gold. The Chinese added fifty tonnes last year and now hold 650 tonnes, which is still less than 2 percent of their reserves.

We expect that the Asian central banks will gradually increase their holdings as gold as an obvious solution to their excessive holdings of dollars which are declining in value. Simply gold is a hedge against further depreciation of the dollar.

Fresh fears over the unsustainability of America's structural deficits was the prime cause for the dollar's three year slide has once again led to another ratcheting up in yields and a lower dollar. The dollar must fall further as the competition for scarcer funds increases.

Moreover, China’s passive reserves are invested largely in dollar assets like treasuries and recently Canadian dollars, euros and gold. China (which is now the world’s fourth largest economy) alone will hold reserves of $1 trillion by the end of this year surpassing Japan's stockpile of $685 billion. All told, Asian reserves at $2.7 trillion continue to finance the massive US deficits.

To date, Asian central bank purchases of US dollars helped prevent the dollar from falling. The resumption of the dollar's decline, will force them to reassess their willingness to suffer further losses of capital.

Meanwhile, the gold mining stocks have not been attracting as much interest as bullion itself. Gold stocks have still not exceeded their previous peaks, last seen more than a year ago.

For some time, now we have said that the lack of performance was attributable to the fact that gold miners do not make much money with gold under $400 an ounce. Only in recent quarters have gold companies have been able to improve margins.

The round of takeovers by Barrick, IAMGold, Goldcorp, Yamana, Glamis Gold and USGold is a reflection that it is cheaper to buy ounces on Bay Street than to spend money in the ground.

Thus our expectation is that with an average price $600 this year, the remaining gold miners will at long last show performance. This consolidation trend will continue however.

We continue to emphasize the mid-cap producers that show growth earnings and production and reserves. Although mining companies are faced with increased costs, many of the junior producers such as Yamana Gold, Eldorado and Bema are bringing in mines over the next twenty-four months. While a rising tide will lift all boats, selectivity continues to be important.

At long last, companies have been able to allocate increased funds to exploration. The juniors are now able to fund both development and higher risk exploration programs.

Moreover, companies with other metals such as copper or silver are no longer being penalized and are adding to revenues due to the increases in commodity prices.

Courtesy of: John R. Ing, Maison Placements Canada