Why gold's going straight to $1,000

By Michael Brush

Gold beat a hasty retreat after setting records by trading north of $840 an ounce earlier this month, but don't be fooled.

It's only taking a breather before it climbs past $1,000.

So this is a good time to get exposure to the metal. I'd buy shares of four well-positioned gold producers favored by two of the top-performing money managers in the sector, which I'll detail in a moment.

Or to get more diversified exposure, you could simply own the mutual funds of these two managers: Thomas Winmill of the Midas Fund (MIDSX) and Frank Holmes of the U.S. Global Investors World Precious Minerals Fund (UNWPX). Winmill's fund is the No. 1-ranked fund for total returns this year, and Holmes' fund topped the charts last year.

Here are four reasons why these two gold bugs and other experts think the metal could see fresh highs soon.

No. 1: The dollar's in trouble

For the next move up in gold, you can thank the Fed. That's because the Fed is going to keep cutting interest rates, which will make investors sell dollars to chase better returns outside the U.S. Investors holding assets in dollars see this coming, so they too will be dumping dollars to avoid the carnage and get their money into something more stable -- including gold.

"The biggest buying pressure for gold is for use as an alternative currency," says Winmill, whose Midas Fund is up 38.5% annualized over the past three years, or 12.7 percentage points better than its category. "It won't take much diversification out of the dollar for gold to go up." History backs this view. Over the past 30 years, the correlation between gold and the U.S. dollar has been greater than 70%, according to CIBC World Markets analyst Barry Cooper.

Is it a sure thing that the Fed will continue cutting rates at its Dec. 11 meeting? No. But that's how the smart money is betting. Wall Street trading suggests bond investors were giving 100% odds of a rate cut when the Fed meets next month, according to Ed Yardeni of Yardeni Research.

It's easy to see why bond investors might take this view. There are plenty of reasons to think inflation won't be much of a threat, giving the Fed the leeway to cut interest rates. The credit crunch is getting worse, and it's likely to begin taking its toll on economic growth soon, says Citigroup (C, news, msgs) economist Robert DiClemente. In a weakening economy, it's harder for producers to raise prices. Consumer spending growth came in at just 0.1% in October, by one measure. In this kind of environment, it will be tough to get price increases on consumer products, says DiClemente.

If the risk of inflation really does subside, that will make it easier for the Fed to cut interest rates without worrying it will stimulate so much growth that prices go out of control.

Even if the Fed doesn’t cut rates Dec. 11, credit market woes and problems in the housing sector that threaten the economy will leave investors thinking a rate cut is still coming. That will continue to put downward pressure on the dollar.

No. 2: Gold production lags demand

While investors chase gold to get into something more stable than the dollar, producers aren't keeping up. Gold production was down 3% last year, and it was flat in the most recent quarter.

Mining companies are spending more on new production -- especially in China and Russia. But that's not offsetting dwindling output from mature mines in places like Nevada, Australia and South Africa, says Citigroup analyst John Hill. Barrick Gold (ABX, news, msgs) recently told analysts it thinks gold production will fall short of market expectations by 10% to 15% over the next three to five years. True, central banks hold a lot of gold. But they are bound by an agreement that imposes limits on sales.

No. 3: Gold producers are buying gold

Traditionally, gold producers have sold gold for delivery at some point in the future, to offset the risk that prices may decline between now and then. Not so much anymore. Apparently sensing more gains ahead for gold, producers are unwinding their hedges.

To get out of hedges, they have to buy gold, which adds to demand. There's more to come, predicts Oscar Cabrera of Goldman Sachs Group (GS, news, msgs). He says both AngloGold Ashanti (AU, news, msgs) and Barrick have been "stung" by mounting losses on big gold hedge positions. "We expect these entrenched positions will ultimately be unwound, providing further catalysts for gold," says Cabrera.

Continued: Gold follows oil

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