How inevitable is further upside for gold?
While the current global macro-economic picture still provides good reasons for higher gold prices, there are perhaps a few other factors at play that are worth considering.
Posted: Friday , 30 Sep 2011
Gold fell over $100 last Friday, Monday continued the carnage and, while the precious metal has regained some ground since, it is still on track for an 11% decline for the week.
The question now on analysts' minds is, where to from here?
For some, this fall is nothing more than a buying opportunity. As currencies race to the bottom and Greece edges ever closer to default, so gold remains the only safe port in a rapidly approaching storm. And, if it was attractive at 1,800 an ounce, it is even more attractive now.
But, there are others that remain a little more circumspect.
In its latest Commodities Weekly note, French Bank Natixis describes this latest fall by gold as "largely contrary to political and economic developments". It adds, "Markets struggled to come to terms with the sharp fall in price, not least because most participants were firmly convinced of the inevitability of higher gold prices."
The bank does, however, offer two reasons that could explain the fall. The first of these it writes is the significant increase in margins by the CME -the group raised its initial margin by more than 20% last Friday.
"As we saw in silver at the end of April, such a rise in margins can result in forced liquidations which in turn create overwhelming negative momentum. Silver prices fell by 27% in just five trading sessions in May, so the 11.5% drop in gold prices between Wednesday and Monday is not totally unexpected," Natixis notes.
The second proffered factor is the loss of, or at least decline in, gold's status as a safe haven. "The increase in gold's price volatility since early July has rendered it a higher-risk asset. Key characteristics of a safe-haven asset are low price volatility and minimal risk of capital loss. With gold price volatility doubling, and gold prices dropping by more than 10% in just three days, these characteristics no longer apply to gold."
Those commentators who fear the end of the world as we know it are likely to dismiss the notion that the dollar offers safer haven than gold, and they may well be right but, there is little denying the increased strength in the dollar over the last week.
As, Natixis points out,
"With the [European debt] crisis escalating in recent weeks, the correlation between peripheral European CDS rates and the strength of the euro has moved to its most negative level (-0.9 over a rolling 3-month period), hence the US dollar has become a more obvious "safe haven." With a flight to quality occurring from many developing country currencies as well, this has accentuated the strength of the dollar."
If gold has indeed lost some of its standing as a safe haven, at least for the moment, then, we could well see a cap on gold prices in the near term.
Especially if, as CPM Group MD, Jeff Christian, suggests, a Greek default doesn't materialise. Christian told Mineweb.com's Gold Weekly podcast that he finds it funny that there are some gold bugs who think he is a bear because he does not believe the world is going to collapse.
Instead, he says, "I think that the gold price could stabilise above $1,200, $1,300 over the next decade and not go away and because I don't think the world is going to collapse and I don't think the dollar and the euro are going to collapse."
"What I see is not a catastrophic failure of the financial system, the global financial market tends to have spasms and it tends to recover from the spasms and this one, as bad as it is, is probably recoverable too," he says.
Rather, he says, he sees investors migrating, over the next few months away from the view that one needs to buy gold at any price because the world is going to collapse to a one where there is recognition that, while the world is not going to collapse, there are major problems that are going to take decades to resolve "and in that environment I want to buy and hold gold for the next 10, 20,30 years but, I can be a little bit price sensitive."
Christian does, of course, admit that this view is predicated on the assumption that European and US politicians do not destroy the world economy over the next 12 months. "We have said it could spike down as low as $1,600 but it could rise back as high as $2,000 or $2,100 between now and December. There are several events that are going to occur in the US government and the European governments that could cause investors to buy a lot of gold."
But, he says, if that does happen, "that may be the time to sell if you are a short term investor. If you are a long term investor, that would be the time to buy puts to cover your long term position."
Natixis is even more circumspect, saying, "With the very real prospect of a messy Greek default over the coming weeks or months, we are hesitant to suggest that the gold price rally is finished just yet. Nevertheless, the price action of the last three months has become increasingly reminiscent of a bubble, as the market squeezed up to prices that were ultimately unsustainable, with both the rise and subsequent fall in prices being accompanied by a significant increase in volatility."
iPad Version - Picture: Gold bars are pictured at the Austrian Gold and Silver Separating Plant 'Oegussa' in Vienna: Lisi Niesner / Reuters