Gold has had a rough ride over the last week, falling from more than US$1,200 an ounce to about US$1,120. But TD economists Derek Burleton and Dina Cover think this is just the start: they see growing troubles for gold in 2010 and they expect the metal to eventually fall back toward its long-term, inflation-adjusted average price of just US$500 to US$600 an ounce.

Despite the recent correction, gold is currently on a big run, and the economists think it will continue in the short-term. They believe the biggest risk is that the market becomes "increasingly gripped by irrational exuberance." Since they expect investors to take advantage of the current dip to buy gold, they think prices will likely spike up again soon.

But starting in 2010, they see gold facing increasing headwinds, the biggest one being the U.S. dollar. As the U.S. economy recovers, they expect forex investors to start pricing in a reversal of some of the "extreme stimulus measures" that have been in place to support the recovery. That in turn should support the greenback.

"This will deal a double blow to gold, since rising short-term interest rates in the U.S. [and elsewhere] will also rein in some of the abundant liquidity and raise returns on alternative fixed-income investments," the economists wrote in a note to clients.

The other factor is inflation. Mr. Burleton and Ms. Cover wrote that inflation worries should subside in 2010. They see it as "highly unlikely" that the U.S. government would try to inflate its debt away, and do not think the Federal Reserve would stand by and watch inflation accelerate.

It adds up to a "less fertile" ground for gold, they wrote. By the end of 2011, they expect the price of bullion to be trading close to US$800 an ounce (you can practically hear the gold bugs retching at that one). Of course, they also pointed out that such a price is way ahead of the average real price between 1983 and 2008, which was about US$580 an ounce.

Looking beyond 2011, they see even less reason to be bullish about gold. They noted that in historical terms, gold has generated little or no return in real terms over extended periods of time, with only a few short bursts where it did really well. And a major long-term drawback of gold is that it does not generate an income stream, unlike dividend-paying stocks. They pointed out that gold has generated a return of 180% from the average price of 1983 to today, far below the returns of the S&P 500 or U.S. treasuries.

"Once financial conditions are more stable, demand for gold is likely to fade in favour of assets that have the potential to generate higher returns, driving gold prices back down toward their long-term, inflation-adjusted average of US$500-US$600 [an ounce]," the economists wrote.

Peter Koven