Gold market update and Outlook
2th July, 2010
Chirag Mehta - Fund Manager (Commodities)
During the previous month, gold continued its advance and set fresh record highs at $1265.30/ounce, while also hitting record levels in Euros, Pounds and Swiss Francs.
And, prolonged financial turbulence in Europe and concerns about a global economic slowdown played an active role in driving investors to purchase gold as a store of value.
For the month of June 2010, prices (measured by the London AM Fix) escalated by +2.18%. Although, prices could not move much beyond the $1265 mark, advances above $1260 saw some selling pressure. The yellow metal did shed some of the gains made during the month on profit booking but managed to post positive returns. Also, on a quarterly basis, this was the biggest advance since the end of 2007.
In the Indian Markets, we saw prices setting record highs above Rs. 19,300/10 grams mark, while prices in rupee terms increased by +2.47% in the month of June.
Sovereign debt issues continued to persist, making it logical for gold to move higher. Demand for gold as an alternative to currencies increased as speculation persisted that debt cutting measures across Europe will slow growth. With such low confidence in Euros, Dollars and other existing currencies, gold seemed to be reasserting itself as a currency.
Europe’s fiscal woes and the dimming prospects for the U.S. economy prompted investors to step up bullion purchases as an alternative asset. Greece’s credit rating was further slashed during the month and an opinion poll showed that a majority of Greeks believe the country may actually go bankrupt. Deteriorating public finances, anaemic economic growth and sovereign-debt and currency concerns should help continue the safe-haven demand for gold.
Gold’s recent rally is not really surprising, given the background macroeconomic uncertainties. However, a point of interest is the fact that this rise has occurred despite a strengthening in the US dollar so far. But, the greenback (dollar) slipped last month following Fed’s (US central banking system) decision to keep the main interest rate at 0% to 0.25% citing the emergence of financial conditions that are “less supportive” of growth. However, gold maintained its upward bias which many deduced as a re-establishment of its inverse relationship with the dollar. However this is mainly a reflection of gold being a true safe haven asset and the insecurity of investors in holding paper assets.
On the fundamental side, investment demand is continuously rising. Refiners were forced to increase production and run at full capacity with extra staff in order to meet heavy investor demand. A refiner mentioned that customer demand was strong enough to constitute “panic buying”, with heavy buying from European nations especially from Germany. This rush-to-grab gold led to tightness in supply and an increase in coin premiums.
Holdings of exchange traded funds reached record levels and have been continuously increasing in tandem with investors’ purchases.
Currently, we are in the midst of a seasonal lull as far as demand for jewelry is concerned and hence the physical market is unlikely to provide much support for gold. Even at these record prices we are not seeing too much of a destruction in jewelry demand, which reflects the fact that consumers are getting accustomed to the record high prices, along with expectations of further price escalation. But traders expect that if prices continue to increase and remain more volatile then it could lead to lower demand and increase in scrap gold coming to the market. Despite a typically weak demand season, if prices go through a phase of reasonable correction, it could trigger heavy purchases.
The International Monetary Fund’s (IMF) gold holdings fell by 15.25 metric tons in May. So far, it has sold 53.75 tons in the market, leaving them with 137.50 tons to be sold. Going by their recent pace, they would be able to sell off their intended gold by February 2011. One important thing to note here is that despite the IMF sales (although small), gold continues to make new record highs.
On the other hand, Russia has continued adding gold to its reserves. It bought 22.46 tons of gold in May and has been buying gold every month since February 10. Philippines also added gold to their reserves this year.
In recent years, the decline in European central banks’ gold sales and increase in Indian, Russian and Chinese purchases demonstrates the growing popularity of gold amongst central banks. China is also looking at increasing its gold holdings in order to diversify its growing kitty of forex reserves.
Outlook:
Entering July, we have seen a sharp fall in gold prices. This has been mainly because of unwinding of Short Euro / Long gold trades. Earlier, due to the problems prevailing in the Eurozone, the Euro experienced a sharp fall and more downsides were expected. However, now that there aren’t any new adverse developments and considering that growth concerns are causing the dollar to weaken, we are seeing a relative rebound in the Euro. This has triggered covering back of Euro short positions. The long positions in gold are also unwounded being a pair trade. This unwinding has also triggered stop losses leading to a sharp fall in gold prices.
However, at lower levels we will see demand coming in and supporting prices.
Fundamentally, nothing has changed for gold. The huge debt issues remain unresolved. Much larger austerity measures are needed to bring in order the rising deficits and debt loads. The recent G20 meeting has pledged to cut deficits and lower debt, but it is easier said than done. Also, there is an increasing probability of the western world slipping into a recessionary phase that would demand government support. The likely central bank response (especially from the US) would be to again to print money and launch stimulus measures which are unlikely to work.
All in all, the world economy is still highly uncertain. The massive debts still remain unaddressed and currencies continue to be debased. In such an uncertain environment, gold will be the much needed "Insurance" for your portfolio. Gold is the only real form of money that can’t be debased and will likely continue to move higher as faith dwindles in paper currencies.
Make the use of recent declines in gold prices to increase your allocation to gold. A portfolio allocation of 15-20% to gold is considered ideal, and a gradual allocation is a more sensible way of reaching this. Keep allocating to gold by buying equal quantities every month irrespective of price levels.
Disclaimer:
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