Gold is ending the first quarter much as it ended the last: rising strongly toward long-term peaks. However, the nature of this rally has changed. Gold is now rising in the face of a weaker euro — breaking the gold/euro correction that became so dominant over the course of 2003 and earlier this year.
This break followed indications from Japan that it may reduce its level of intervention to prevent appreciation of the yen. The potential for Asian currencies to appreciate against the U.S. dollar could support gold in the coming months, despite a weaker euro. This would mark a reversion back to the traditional relationship between the gold price and the trade-related U.S. dollar.
However, the rise in gold has not been driven only by currencies. There are growing concerns about the economic recovery, equity markets have faltered, and the tragic bombings in Madrid and Baghdad have once again raised the spectre of global terrorism. This has all provided a further boost to the move into alternative assets generally, and commodities, including gold, specifically.
We have modestly reduced our 2004 gold price forecast to US$410 from US$420 per oz. but only because the first-quarter average underperformed our expectations.
We still believe gold will ride the final leg of this rally to a fresh peak in the second quarter of 2004. However, a recovery in financial markets and the U.S. dollar would lead to significant long liquidation, and the concern for gold is that weak physical demand and a slowdown in producer de-hedging will allow for a marked retracement in prices.
The key to sustaining, let alone continuing, the bull run in gold remains the success or otherwise of the industry’s attempt to revive broader investor interest.
Gold has withstood some long liquidation, but speculative long positions have returned to historically high levels. Many of these short-term speculators are systems-based traders, and gold has closely followed technical signals. The rebound from US$390 per oz. back above US$420 in March should allow prices to test fresh long-term highs. However, we continue to highlight that these speculators are, in the main, not long-term investors. Hence, gold remains highly vulnerable to a reversal of the technical outlook. Indeed, owing to weak physical demand, gold is more susceptible to this than most other commodities.
Arguably the most important development in the gold price trend in recent months occurred in March. Movements in the euro through 2003 dominated gold, so signs that European central bankers were getting more concerned about euro appreciation encouraged speculators to reduce their long positions in gold.
More recently, however, gold has closely followed the trend in the yen. This reflects a change in focus for the weaker U.S. dollar from simply the euro to the Asian currencies. Several factors — indications that the Japanese will reduce their massive intervention; appreciation of the Indian rupee, Thai baht and won; and the potential for revaluation of the renminbi — suggest that the U.S. dollar may weaken further on a trade-weighted basis. This is clearly an important support for gold at present.
The sizable decline in equity markets from early 2000 until mid-2003 created a supportive environment for gold. The fact that this coincided with a volatile and uncertain performance across the major financial markets, bonds and currencies encouraged investors to consider all alternative assets, with property and commodities, including gold, benefiting in particular.
The recovery seen across most equity markets last year was a threat to gold, as was the good start to the year based on the back of stronger economic growth and higher corporate profits. However, equities faltered in March, with concerns about the strength of the recovery and rising input costs threatening profitability. Barclays Capital remains positive on equities and the economic outlook over the course of 2004, and we expect positive financial market performance to dampen gold prices during the second half of 2004.
The relationship between inflation and gold is an enduring one. Gold is a genuinely tradable hard asset and so should hold its value against paper assets as inflation rises. Inflation is becoming an increasingly common topic, with loose monetary policy and rising commodity prices causing concerns for the future.
However, underlying rates of inflation are low. Also, gold has arguably already factored in more expectations of inflation than bond markets. And lastly, there is now a wide range of inflation-protected paper assets on offer to the potential consumer, and these offer greater liquidity and lower risks than gold.
Hence, inflation — at this stage — is a supportive, rather than driving, theme for gold.
Gold equities tend to trade in line with the daily moves in spot gold prices, but divergences in the equities can occasionally be an early signal for changes in sentiment. We note that the implied price from the HUI Gold Bugs Index of unhedged gold companies has tended to factor in a higher gold price than spot through the second half of 2003 until its double peak from early January. Since then, the implied HUI gold price has fallen to trade in line with spot gold. A fall below spot gold would be a worrying signal for gold prices. Also, gold producers in other regions and with hedge positions have been discounted. This divergence has encouraged existing hedgers, such as
The big gold-market news for the first quarter of the year was the announcement, in early March, of the renewal of the European Central Bank’s Gold Agreement. The text is as follows:
In the interest of clarifying their intentions with respect to their gold holdings, the undersigned institutions make the following statement:
— Gold will remain an important element of global monetary reserves.
— The gold sales already decided and to be decided by the undersigned institutions will be achieved through a concerted program of sales over a period of five years, starting on 27 September 2004, just after the end of the previous agreement. Annual sales will not exceed 500 tonnes and total sales over this period will not exceed 2,500 tonnes.
— Over this period, the signatories to this agreement have agreed that the total amount of their gold leasings and the total amount of their use of gold futures and options will not exceed the amounts prevailing at the date of the signature of the previous agreement.
— This agreement will be reviewed after five years.
The renewed agreement was largely within expectations. The increase in annual sales to 500 from 400 tonnes was toward the top end of expectations but not by such a degree to have a negative impact on sentiment. The U.K. did not sign the agreement but seemingly only for political reasons. There are market doubts about whether there are sufficient sellers to reach 2,500 tonnes over five years — but the figure came from somewhere!
There were no positive surprises either. The lack of new central banks joining the agreement (such as the new European Union entrants or South American central banks) disappointed some in the market. Similarly the wording on leasing and use of futures and options were more open than some had expected.
A key support for the rally in gold prices has been the move by major gold producers to reduce their forward sales book in response to shareholder reactions, rising prices and low interest rates. Furthermore, the acquisition of hedgers by non-hedgers provided fuel for significant reductions in hedge books.
However, several of the major gold producers have now reduced their hedge books toward their target levels, and many of the remaining structures are difficult and expensive to reduce. As well, project finance, with some hedging requirements, is now occurring.
We had been expecting a major slowdown in de-hedging. However, the change in stance from the world’s largest hedger, Barrick Gold, to abstain from hedging for the next decade and reduce its hedge book to zero, plus another wave of industry consolidation, means de-hedging will remain a supportive factor in 2004 — but still less than in the 2001-03 period.
— The opinions presented are the authors’ and do not necessarily represent those of the Barclays group. For access to all of Barclays’ economic, foreign-exchange and fixed-income research, go to the web site at barclayscapital.com. Queries may be submitted to the authors at kevin.norrish@barcap.com and kamal.naqvi@barcap.com
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