A cautiously optimistic gold forecast

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, delivered recently in Toronto, 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 complementary factors to the falling dollar: the decline in U. S. bond yields, the subprime mortgage crisis and the overall commodity supercycle.

Based out of New York, Steel has had a front row seat from which to watch the subprime crisis that has hobbled Wall Street for months, and he said it affected the gold price by 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 U. S., 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$1,000 an oz.

But lest investors become overly optimistic, not all the cards are lined up in gold’s favour.

Steel noted that while big U. S.

funds had been short on the greenback and long on gold — correctly anticipating gold’s rise and the dollar’s 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 supplyofscrap metal, which would lower prices.

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

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

“Theyarefaced 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 in- Federal Reserve is expected to continue tocut rates — which would fuel inflation and be good for gold prices — Steel warned that if that expectation changes, so too will 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 9/11.

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 the 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.