Despite gold’s latest weakness and the possibility of further breakdown, I believe we are nearing a turning point in the tenor and direction of the market. Before long, gold will begin a new and sustainable upward march.
Until then, with the yellow metal in the $700 to $730 range - and certainly at lower price levels - price-sensitive demand from key Asian and Middle Eastern markets should stabilize the market.
With $1000 gold very likely in the next year - and still higher prices beyond - the risk/reward ratio is very much skewed to the plus side.
Commodity Disinvestment Running Its Course
As I have written in past Gold Briefs, much of gold’s weakness in recent months can be blamed on a wholesale indiscriminate shedding of long commodities positions. Often sellers were not holding individual commodities but baskets or indexes that included gold - so gold got dumped with everything else.
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Despite this morning’s sharp sell-off in precious metals, the key factors favoring gold, silver, and the platinum-group metals remain in place.
Gold, in particular, has been acting much like a currency, reacting negatively to strength in the U.S. dollar in recent weeks, just as the depreciating greenback early this year was mirrored in gold’s swift run-up into four-digit territory. And, the short-term outlook – for the days and weeks ahead – still depends very much on the fate of the U.S. dollar.
Both big moves – first up to US$1034 and then back down to the $850 vicinity –reflect, in large measure, the flow of speculative funds in and out of gold as traders and fund managers reacted to the unfolding monetary, financial, and macroeconomic situation in the United States.
Recent weakness is best seen as a period of consolidation, shaking out many of the short-term traders, speculator, and hedge funds. The drop in bullion deposits held by exchange-traded gold funds suggests that hedge funds lacking any long-term allegiance to the yellow metal have been taking profits over the last few weeks.
Following the Federal Reserve’s latest quarter-point cut in its Fed fund and discount rates, suggestions that further interest rate reductions may be slow in coming have boosted the greenback and knocked the gold price for a loop.
However, sooner or later, in the face of a deteriorating economy – and fearing a protracted and painful recession – the Fed will almost certainly resume its reflationary (and ultimately inflationary) monetary policy by lowering interest rates still further and providing easy credit to the banking system. Ultimately, rapid growth in money spells rising inflation and higher gold prices.
In the background, however, gold’s actual supply-demand fundamentals continue to tighten, in part supported by the worldwide acceleration in price inflation.
On the back of surging food and energy prices inflation seems to be rising just about everywhere. Europe, the Mideast, India, China, and elsewhere in Asia all report higher inflation in recent months with little hope in sight for more stable prices – and this will also drive gold higher.
In particular, the rise in inflation in the Middle East and Asia may explain the resiliency of physical demand in these markets with buyers adjusting rather quickly to higher price levels. Importantly, at recent levels between $850 and $900 buyers have been returning to the local markets in the Mideast, India, China, and east Asia – and this bodes well for the future.
So, even if U.S. recession fears are slow to develop (or if we are wrong and the recession is short and shallow), gold will begin responding favorable to its own market fundamentals. In the medium-to-long term, it’s not a question of direction for gold but of how fast and how far the bull market will carry the yellow metal.
Odds are the price of gold will again surpass $1000 an ounce later this year and push into new heights in 2009 – but, if we are wrong, it’s likely to be in timing and speed, not direction. Longer-term, prices in the $1500 to $2000 range seem quite likely.
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