Steel: Cautiously optimistic on gold

Getting laughs out of the crowd at the Prospectors and Developers Association of Canada (PDAC) convention comes as second nature for HSBC’s jovial analyst Jim Steel. But in his 2008 forecast for the yellow metal, Steel offered insights that could have some gold bugs brooding.

After deconstructing an array of factors playing on the gold price, Steel concluded that while prices should remain high for the remainder of the year they likely won’t stay at present levels.

On the way to his conclusion Steel first took time to examine how the price of gold arrived at its current lofty peak.

Adamant that a rise in prices can’t be reduced to one factor such as the decline in the U.S. greenback Steel offered as compliments to a falling dollar: the decline in U.S. bond yields, the subprime mortgage crisis and the over all commodity super-cycle.

Based out of New York, Steel had a front row seat from which to watch the subprime crisis that has hobbled Wall Street over the last many months, and he said its impact on the price of gold came from its spurring safe haven buying from large investors.

He said while such a crisis pushes people away from soft assets like dollars and into hard assets, traditionally that hard asset had been real estate. With the collapse of the real estate market in the US, however, gold gobbled up much of those investment dollars.

Also fuelling gold’s recent run are supply-side factors. Overall global production has been “sluggish” in Steel’s view, and the major central banks have limited their selling of gold into the market.

When all these ingredients are stirred into the cocktail, you have a drink with a value approaching US$1000 an oz.

But lest investors get caught-up in an overly optimistic attitude, not all the cards are lined up in gold’s favour.

Steel noted that while big US funds had been short on the greenback and long on gold correctly anticipating gold’s rise and the dollars decline — recently they have been cutting back on their shorts.

“Which usually means longs on gold will come down in the short term,” he said.

Another factor that could weigh down prices is a downturn in jewelry demand. Steel says a clear dichotomy is emerging between investors who are buying gold and retail consumers who are not. The situation means more people are likely to turn in their jewelry thus increasing the supply of scrap metal which would lower prices.

Such a scenario unfolded in 2006, Steele said, and it undermined the gold rally then.

Also weighing on the cautionary side of the scale is supply in South Africa

“They are faced with physical surplus, which is easy to ignore if one keeps looking at the credit crisis and the dollar,” Steel said.

The last significant factor that investors should be on the watch for is a change in expectations regarding U.S. monetary policy. While expectations now are that the Federal Reserve will continue to cut rates which would fuel inflation and be good for gold prices Steel warned that should that expectation change so to would large investors’ desire for bullion.

Overall, however, Steel said gold’s role as a barometer of the wider social economic climate bodes well for prices. After all, he says, low gold prices in the 90s coincided with a feeling that things were good in society a sentiment that drastically changed after 09/11.

And if global pessimism weren’t enough good news for gold bugs, there’s always the movement of longer term investors into the commodity to warm their hearts. Both older investors and pension funds are moving in and both groups have a longer term outlook on their investments meaning lower gold prices in the short term won’t trigger selling.

For those investors who look for coefficients to trade off Steel offered one beyond the much discussed relation between the price of gold and oil — the movement of the world’s second strongest paper asset.

Historically gold traded in line with both the Deutschmark and the Yen when they played second fiddle to greenback. And while acknowledging that by the end of his speech the situation may change, currently the greenback is still the world’s strongest paper asset, leaving the Euro to play the part of second fiddle and hence coefficient to the price of gold.