Jul 12 2012
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EU exits good for gold?
"The implied chance of a country exiting the euro by the end of 2012 is currently around 25%. What's more a definite exit (i.e. a probability of 100%) would be consistent with a gold price as high as $2,500," notes a Capital Economics analyst.
However, headwinds from the American dollar would clip gold's rise, which has forced Capital Economics to forecast a more moderate $2,000 per ounce target by the end of the year.
Another contributory factor for CE's record gold price forecast is the prospect of sustained low interest rates in the U.S. and almost all major advanced economies. This minimises the opportunity cost of holding an asset like gold that pays no income.
Yet another factor giving gold a strong momentum is the massive purchase by central banks over the past few years.
The World Gold Council estimates that central banks had bought nearly 300 tonnes of gold in the fast quarter of the year, led by the central banks of Turkey (+93 tonnes), Russia (+85 tonnes) and Thailand (+44 tonnes). This equates to approximately 11% of world mine production and continues a significant change from the past, when central banks were net sellers of 400-500 tonnes annually.
There could be much more where that came from.
Source: World Gold Council
"While advanced economies held, as end-2011, on average 22% of their reserves in gold, emerging-market central banks held on average less than 4%," wrote Ashish Bhatia, an analyst at Royal Bank of Scotland.
Emerging central banks, which are heavily exposed to the American dollar consider gold reserves as a great hedge against dollar-denominated assets. According to RBS data, gold's correlation with the dollar over the past decade has been -0.44 - which is significant.
"[Gold] is exceptionally stable when compared to the relative instability of other typical reserve assets like sovereign bonds,' said RBS's Bhatia.
Not everybody is convinced central banks will continue to be buyers, however.
When the gold price is observed from a BRICS perspective, it appears near all-time highs, notes Daniel Brebner, Deutsche Bank commodities economist. "Coincident with the decline in energy/metal values some emerging central banks could moderate their buying over the near-term as a response to these factors."
A GOLDEN CHANCE?
But if all the indicators seem to be pointing to a meteoric spike in the price of gold, why has it only risen by a mere $5 since the start of the year?
During this time, the world has been at the brink of disaster many times, with the European crisis leading the parade of bad news in the first half of the year.
Gold fared much better in the first quarter, before losing ground by the second quarter.
But even while the yellow metal had risen nearly 9% in the first quarter to reach USD$1,662.50 per ounce, it was eclipsed by the regional markets of Dubai, Saudi Arabia and Egypt.
Internationally, S&P 500 climbed 12.1% and the U.S. real estate rose nearly 10% during the period, apart from MSCI World Index and Brent crude oil, which all outperformed gold.
So why hasn't the safe haven spiked and offered some cover to the hapless global investors.
One explanation is that gold is taking a breather after posting double-digit growth in six of the last seven years, including an uninterrupted double-digit streak in the past three years.
"What's more gold is now behaving like a risky asset," notes Capital Economics. "This can be seen in the unusually high positive correlation between daily changes in the prices of gold and European equities."
However, this is a new phenomenon, given that gold historically did well during the dot.com bubble, Lehman Brother collapse and the U.S. debt ceiling crisis last year.
In addition, physically backed exchange-traded funds are stagnating over the past six months, suggesting investor might be cashing out to make up for their losses elsewhere.
LOOK OUT FOR Q4
Deutsche Bank believes these headwinds for gold will subside by the fourth quarter. Gold has been in correction mode for much of the year and has fallen roughly 15% since it touched the magical USD1,900 per ounce last year.
"We also anticipate that conditions will remain fairly static into early Q3, with gold likely trading in the USD1,550- 1,600/oz range," said Deutsche Bank's Brebner. "By the end of Q3 however, into September, we believe that the potential for policy action could increase significantly; and as the market anticipates this, gold has the potential to move beyond USD1,700/oz."
"Government action or intervention is likely to come in the form of credit expansion and while we question the effectiveness of such action in sustainably supporting growth in the western world, we do believe that it will have the effect of pushing up gold prices as the metal responds to the implied erosion in value of money (USD)," said Mr. Brebner.
That could be the spark that ignites the next gold rush - but if it doesn't, it would surely mark the end of the decade-long gold bull rally.
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