Where Next for Gold?

July 9, 2013 at 05:39

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Nouriel Roubini, the US economist nicknamed Dr Doom for his frequent predictions of impending financial misery, is used to a bit of hostility.

His warnings early in the credit crunch that the crisis would intensify and cause a global recession prompted scorn from his critics (often accompanied with mocking references to his reputation for throwing lavish parties at his trendy New York home, where the walls were adorned with modern art – including plaster of Paris vaginas).

Still, the anger directed at Roubini following his latest warning of another impending crash is on another level, with internet bloggers accusing Dr Doom of being part of a global conspiracy to rig the market. This is what can happen to those who dare suggest, as Roubini has, that the gold price is heading for a serious fall.

Investors in gold are passionate about their chosen asset class. Bearish analysts are frequently dismissed as naive fools who don’t understand the allure of a real asset (as opposed to paper money). But the animosity directed at Roubini for his prediction that the gold price, currently at around $1,400 (£917) an ounce, will fall to $1,000 by 2015, also reflects nervousness about recent market events.

After all, a three-year bull run in gold came to an end in the autumn of 2011, when prices peaked at around $1,900. Over the subsequent 18 months, gold traded in a relatively narrow range between $1,600 and $1,800, only to take a precipitous plunge in April to close to $1,300, 30% down on the high point. There has since been a bounce – but only a modest one.

Cyprus rarely has much of an impact on world markets, but the country’s gold sell-off appeared to trigger April’s crash. The 12-tonne sale – Cyprus needed the cash to address its fiscal crisis – was tiny in the context of a market where hundreds of tonnes of gold are traded every day, but it crystallised many of the fears Roubini – and others – articulate.

The bears’ case is that the gold price was driven up by two factors in particular: a fear of mounting financial and geopolitical risk on a global level – the sort of worry that tends to push investors towards real assets such as gold – and nervousness about the inflationary impact of policymakers’ responses to that risk, especially the huge quantitative easing (QE) programmes pursued by central banks around the world. This unprecedented increase in the money supply would, in normal times at least, be associated with spiking inflation, and gold is the classic defence against rising prices.

However, the gold bears point out that these risks have not materialised. The worst of the financial crisis seems to be behind us and there are even some green shoots to be seen in Western economies – particularly in the US. Moreover, inflation has stayed low in most parts of the world by historical standards. On this basis, higher gold prices are not sustainable. “The gold rush is over,” is how Roubini puts it.

He is not alone in this view. “The gold price is, in our view, in bubble territory,” argues Michael Haigh, head of commodities research at Société Générale. “Now we are beginning to see the economic conditions that would justify an end to the US Federal Reserve’s QE, fiscal stabilisation that has passed its inflection point and a US dollar that has begun trending higher, it seems unlikely investors would want to add much to their long gold positions.”

SocGen’s forecast is for a 2013 year-end gold price of $1,375, but analysts at the bank also think there is a small but significant risk of a much more dramatic collapse if economic news surprises on the upside.

Russ Koesterich, chief investment strategist at BlackRock, is also wary about the prospects for gold – even without an end to QE. “Low and falling inflation means there is little pressure for the Fed to take its foot off the monetary accelerator,” he argues. “All else being equal, declining inflation is likely to result in lower prices for gold, since investors will be less inclined to seek out inflation hedges.”

But is all else equal? The consensus forecast among gold analysts, says Bloomberg, is for gold to end the year at $1,752, well above the current price. That suggests many in the market think other factors will come into play – and that hope for sustained low inflation and economic recovery may prove premature.

One such factor, says Frank Holmes, chief investment officer at US Global Investors, is the continued low level of interest rates in so many markets, which means investors in many assets are earning negative returns. “The maths indicates that the metal will not stay at these lows,” Holmes argues. “In this negative real interest rate environment, we believe gold will return to more normal levels.”

Another reason to be positive is that demand remains robust. Cyprus may be a seller but the World Gold Council’s statistics show central banks continue to add to their gold reserves. They bought 109 tonnes of gold during the first three months of the year, with Russia and South Korea among the biggest purchasers.

These purchases were stepped up in April and May. “The price drop in April, fuelled by non-physical moves in the market, proved to be the catalyst for a surge of buying that has left many retailers short of stock and refineries introducing waiting lists for deliveries,” says Marcus Grubb, managing director at the World Gold Council.

Then there is the low rating of the US dollar to consider. With gold priced in dollars, any weakness in the US currency should provide a lift for the metal because it becomes cheaper for investors everywhere else in the world to buy. The dollar has actually strengthened in recent months, following more encouraging economic news in the US. However, the appreciation has been modest and from a low base. Moreover, with economists doubtful the US Federal Reserve will tighten monetary policy any time soon, there is no immediate prospect for a sustained recovery in the dollar.

Its also worth considering whether the claims made by gold bulls that policymakers strive to keep a lid on the gold price (with tactics such as selective leaks of limited information) have substance, as Thomas Paterson, chief economist at Goldmadesimple, suggests.

“Many gold-watchers are highly suspicious that the market in gold is deliberately manipulated to keep the price in check,” he says. “These views are often met with almost laughing disdain, which is odd given that the whole Libor manipulation of interest rates really proved to the world that manipulation in markets is common and can happen on a massive scale.”

Manipulation is hard to prove, but if the recent volatility in the market is partly explained by attempts to manage the price down, there is scope for appreciation as the fundamentals reassert themselves.

It’s not credible to suggest Roubini is a manipulator, and he concedes that the gold price may rise further before heading down. And therein lies an irony: while gold is considered a safe investment, we are seeing the sort of volatility associated with asset classes such as equities. With powerful and conflicting forces at play, that volatility looks set to continue.