Dull Economics to Keep the Shine on Gold

June 9, 2012 at 07:17


Gold proved its worth during the equity market falls of 2011 – peaking in August at $1,923 and returning 10 per cent in the year. But an 18 per cent reversal to $1,575 this year is leading some to ask if the bull run is over.

‘[Until the peak], the price had not traded below the rising 200-day moving average (a long-term trend indicator) since January 2009, but the correction means that the trend channel has broken down,’ says Richard Perry, chief market strategist at broker Central Markets.

Some of the economic drivers of the 2011 gold rush also appear less powerful, analysts admit. Early 2012 brought evidence of a US recovery – reducing the chances of more liquidity creation through quantitative easing (QE) stimuli. It had been the QE programmes in the US and UK that depressed interest rates, the dollar and sterling – boosting demand for gold as a currency alternative, and a hedge against resultant inflation.

”There is no income stream or dividend from gold, but in a negative real interest rate environment there is very little opportunity cost to owning it,” notes Perry.

Gold lost some of its sheen in India and China, too, which between them account for 40 per cent of global demand. “Indian gold imports dropped 65 per cent in April compared to the prior year, on the back of a higher tax on gold imports and volatility in the Indian rupee,” explains Bill O’Neill, chief investment officer at Merrill Lynch Wealth Management.

Even European investor appetite reduced in early 2012, as eurozone debt fears briefly relented.

However, Angelos Damaskos, manager of the Junior Gold fund, does not believe the yellow metal will see a major correction. “Many investors thought last August was the peak for gold – that the measures taken then had brought the sovereign debt problems under control, and that economic growth was on the cards,” he argues. “But the problems have not been resolved and in fact are likely to get worse, driving people back to gold.”

He believes that the greater likelihood of a Greek exit from the eurozone will boost demand from nervous investors. ”If the concept of the Eurozone is damaged, sovereign bonds in Spain and Italy are likely to be downgraded, in which case the European Central Bank will have to provide more support via QE,” he suggests.

Further quantitative easing in the US, as well, will have knock-on effects on the gold price, adds O’Neill.

Edel Tully, strategist at UBS, says that the main problem for the gold price is a lack of momentum, as investors remain wary of buying into a falling price.

“Momentum will return in due course – but it will take an extreme event, such as Greece exiting the eurozone, to kick-start safe-haven demand,” she says. UBS has reduced its price forecast from more than $2,000 to $1,680/oz.

Damaskos is more bullish, forecasting a price above $2,000 by the year end. He points to the fact that the Chinese and Indian governments have been buying gold in the wake of the recent sell-off, to diversify their reserves away from dollars and euros – and they are long-term buyers. “When the traders do come back into the market, supply will be short,” he predicts.

At Merrill Lynch, O’Neill thinks governments’ need to expand the global money supply is likely to push up the price as high as $1,875 by the fourth quarter. Perry agrees. ”The fundamentals are still in place for a positive gold price [this year] – this period of consolidation could just be a pause for breath.”