Gold: the recovery has begun but long-term forecasts still range widely

Vancouver – The yellow metal might have underperformed over the last few months but recent price increases have prompted analysts to predict at least a short-term rally for gold, whether major markets head into recession or recovery.

 

The last few months excluded, it has been an epic year for gold. In March, after a sustained climb, the precious metal broke the US$1,000-per-oz. barrier for three days. Through the middle of the year the price stayed above US$850 per oz. A sudden drop in September foreshadowed the economic mayhem to come, but even then it spent much of the month near US$900.

 

But when the financial crisis hit for real in October, the price of gold fell along with everything else. After flirting with $900 per oz at the beginning of the month the price collapsed, hitting its lowest in over a year of US$712 per oz. on Oct. 24. Many investors were taken by surprise, having been told for years that when all else fails people turn to gold as a secure investment.

 

The price of gold remained depressed for almost a month, during which time trading was highly volatile. But by mid-November the price started to climb back up, including a few record one-day gains. Now most research groups are predicting a slowly gaining, relatively stable gold price over the short term. As for the long term, predictions range from $650 to $2,000. But to understand predictions of what’s to come, one must first understand what just happened.

 

Key to gold’s poor performance over the last few months is the role of institutional players and investment funds. Faced with red balance sheets, institutions and funds needed cash and so they sold gold. In fact, they sold almost anything for which they could find buyers; gold can always be easily liquidated so it got hit hard.

 

Adding to the apparent correlation between world equity markets and the price of gold, some wealthy investors and funds sold gold to meet margin calls, cover losses on major investments gone bad, or simply wind down and return initial cash contributions to investors. A few large banks even got into the gold-selling fray, for the same reason: to raise needed capital and increase liquidity.

 

And even though the price of gold was down some 24% compared to its March high, other commodities – not to mention stocks – were down further, which meant gold sales were an avenue by which to minimise losses. As such gold’s relatively strong performance made it more of a target.

 

It appears that the October-November wave of sustained liquidation of long gold futures has abated, likely because positions are exhausted. On the flip side, new buyers have emerged. One important one is the People’s Bank of China, which is considering increasing gold reserves nearly seven-fold from its current 600 tons to 4,000 tons to spread the risks in its huge foreign exchange holdings. And Indian jewelry demand remains strong.

 

Another major influence on the price of gold is the strength of the US dollar. Massive injections of liquidity by the government have driven a recovery in the US dollar of late, but this recovery is likely going to be short-lived. As Jeffrey Nichols, manager of American Precious Metals Advisors, puts it, “The US government is printing money so fast, cash is not even a safe bet any more…The massive infusion of liquidity is ultimately going to lead to a massive spike in capital flows and an upward pressure on inflation.”

 

Inflation is good for gold prices: it drives the value of the dollar down and so encourages people to seek a safer refuge for their savings. Gold is a classic safe haven. And with the US Federal Reserve expected to cut interest rates to 0.75% from 1% in mid-December, bullion’s appeal is on the rise as an alternative investment to the US currency.

 

Interestingly, deflation is also good for gold. Deflation is a persistent reduction in the general price level, not just for goods and services but also for most commodities, real estate, equities and other assets. It stems from declining demand and an unwillingness to spend. During deflationary periods savings – and safe savings investments like gold – grow. As such gold is well-positioned as both an inflation and deflation hedge.

 

Then there is the actual supply-demand side of the equation. Based in part on China’s plans for a strategic gold reserve, Wellington West Capital Markets is forecasting a structural deficit in gold supplies, which will push prices up.

 

The analysts behind the report – Catherine Gignac, Paolo Lostritto, John Miniotis, and Ryan Walker – note that investment demand for physical gold increased by 179% in the third quarter, compared to last year, and that bullion dealers in many parts of the world reported “severe stock shortages of bars and coins”.

 

And they believe the change will be significant: “Given the potential change in market fundamentals, we believe it is time investors revisit investing in the junior and intermediate gold producers.”

 

It seems some investors never stopped thinking of gold as a safe place to stow away money. According to the World Gold Council, demand for gold reached an all-time high of US$32 billion in the third quarter. The huge deleveraging of commodities by hedge funds and institutions more than offset the massive demand, hence the drop in price, but the demand means investors – including the all-important Indian jewellery market – took advantage of gold’s depressed price, buffered its drop, and in doing so set the stage for its rise.

 

So where is the price going from here? Predictions are all over the map.

 

In their latest note Fortis Investment Research analysts wrote, “Gold is getting almost impossible to call, with daily price moves of $20 per oz. no longer rare. We’re mildly bullish, as the dollar’s rally is likely to run out of steam. But when will that be?”

 

The group set its 1-month forecast at US$730 to $820 per oz. Fortis then predicts a price of US$825 over 2009, falling to US$800 for 2010, and foresee a gold price of just US$650 from 2011 on. 

 

Haywood Securities is pretty much on-par with Fortis. Haywood’s analysts are more bullish on gold on 2009, forecasting an average price of US$900 per oz, but in 2010 they predict the price will fall to US$700 and agree with Fortis that in the long term the price will settle to just US$650 per oz.

 

Genuity Capital Marlets analysts see the future a bit differently: they are less bullish in the short term but more so in the long run. “With safe haven buying of the US dollar, unwinding of the long commodity trade, and plummeting inflation expectations expected to continue in the near term, it is increasingly difficult to remain overly bullish on bullion in the short term.”

 

Genuity’s analysts forecast gold prices of $740 per oz. for 2009 and US$751 per oz. for 2010, with the average price rising some US$25 per year until 2013.

 

Resource Capital Research, an Australian group, has a slightly more bullish outlook. They see prices moving between US$750 and US$850 per oz. over the next month, moving up to US$900 an oz. in 2009. Nichols, the manager of American Precious Metals Advisors mentioned earlier, predicts prices of US$1,000 per oz. “sooner rather than later”, but hesitates to be more specific.

 

The most bullish predictions, however, come from Citigroup, the research branch of the mega American bank that was gasping for air when the US government handed it the largest bailout package in history: US$20 billion on top of the US$25 billion that bank picked up in October.

In a Nov. 26^th research note Citigroup chief strategist Tom Fitzpatrick argued for a bull gold market because of gold’s flexibility. He says if the massive monetary and fiscal bailouts of late successfully reflate the global economy, gold will benefit by acting as a hedge against inflation. On the other hand, if rescue plans fail and economic instability worsens, gold will see upside because of its safe haven status.

 

“We continue to believe that a move of similar percentage to that seen in the 1976-1980 bull market can be seen, which would suggest a price north of $2,000 [per oz.],” Fitzpatrick wrote. He cautioned, though, that Citigroup is not forecasting an imminent move towards $2,000; rather, it is a scenario likely to unfold in the next few years.

 

Whatever happens, it is clear that gold remains a key player in the global economy and that analyzing or predicting its price is a difficult game.