Gold rally could start to tire

November 26, 2009

JaneFoley.JPGSpot gold prices are up over 40 percent year on year.  Yet, according to the World Gold Council, demand for gold in the third quarter of 2009, dropped by 34 percent year on year.  Of course, demand in the third quarter of 2008 was exceptionally high due to the financial crisis. As well, relative to the third quarter average of the five years to 2007, demand for gold in Q3 2009 was down 4 percent.

When confronted with the ferocity of the rally in gold, the fact that the third quarter demand for gold was below the seasonal average is surprising. The dynamic between price and demand suggests some fall in supply perhaps led by increased hoarding.

According to the council mining supply is fairly inelastic.

Supply of recycled gold generally helps stabilise the price, in recent years this has been 28 percent of annual supply.   Between 2003 and 2008 central bank sales represented the third biggest source of supply.

It remains unclear what the recent gold purchases from the Central Bank of India means for the demand/supply dynamic of gold going forward.

What is clear, is that the gold rally has been exacerbated by dollar weakness, but this only offers a partial explanation.  The dollar index is at 15-month lows.  In August 2008, gold traded at an average rate of $836.84.  Other factors that have chased gold prices higher include the lack of return on cash and fear of inflation.   The former will almost certainly support gold in the coming months, but the inflation argument has no legs.

Following a year packed with fiscal spending and the introduction of Quantitative Easing, Fed chief Bernanke recently said “inflation seems likely to remain subdued for some time”.  If high unemployment and rising savings rates are insufficient evidence of subdued price pressures, lessened availability of credit at a consumer level should drive home the point.

Tightening the availability of credit on Main Street has been an inevitable and necessary consequence of the subprime crisis. Not only should this ensure that consumer activity going forward stays relatively subdued but is also implies that firms will have less pricing power.

Rather the causing domestic inflation, cheap money provided by the Fed and other central banks can be linked with speculator inflows into high yielding markets.  Some asset prices in Hong Kong, China and Singapore are arguably seeing the beginnings of bubbles and this talk alone is supporting gold.

The Fed could hinder this by hiking rates so the dollar was no longer an attractive funding currency but it is unlikely to do so when its domestic economy is weak and expectations for domestic inflation are low.  Like the Bank of Japan in the 1990s, it is possible that the Fed’s ability to create inflation domestically may be lessened in the post crisis era.

While it is difficult to find signs of inflation in the US, Eurozone or UK, near zero interest rates are clearly providing a significant support for gold.  Speculation in general is being fuelled by cheap USDs but in addition, conservative and retail investors are being forced to look outside cash deposits for positive return.  Also, retail investors cannot be blamed for enjoying the intrinsic quality of gold following last year’s banking crisis.

Assuming the Fed starts to hike rates in the second half of 2010 the dollar could see a cyclical recovery on a 6 month view.  Anticipation of higher Fed rates and a stronger dollar should reverse some of this year’s flows into gold.  While this suggests that the gold rally may yet run for another 6 months , the third quarter demand data for gold implies the rally may tire as soon as the first quarter.


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Good timing…

Posted by Daniel M. Ryan | Report as abusive

Jane,I dont know what your background is but I~m afraid your drasticaly wrong in your interpretation. Gold will continue to go up and up – why – because most developed countries Governments are banktrupt -USA, UK and Japan. These countries either face up to a massive 10-15 year depression as interest rates soar to above 10% and destroy western asset values (property inparticular). They have not the tiniest of hope of ever repaying their debts. Instead they will (and are choosing) to inflate away their debt by continued money printing (i.e. monetising their debt). Do your homework and read up about history and you will understand why gold may well top 10.000 USD per troy ounce in the next 5-7 years.Inflation is not apparent as yet,but overtime it will creep up and for many will be to late as they see the purchasing power of their savings reduced to as little as 0 over time. Remember Brazil,Bolivia, Hungary etc.Hyprinflatnary periods follow deflationary periods. THey succumbed to hypeinflation after desperately trying to cover 10% budget deficits by printing money. Lesson in economics if you triple the money supply you ultimately have 3x the money chasing the same number of goods and services. Im sorry but that is massively inflationary.

Posted by Michael | Report as abusive

Sorry but you could not be more wrong. Gold is going to $1300/ ounce by the end of this year and to $2400 by next year and may go to $5000 in years to come.We already have inflation in the US, where do all these people live who do not say we have inflation-Mars? We have inflation in housing, stocks, the bond market, food, energy, college tuition, medical, and insurance just to name a few.The fed also has no out for its policies without really screwing up the fiat money systems all around the world.Also all across the world fiat money systems are under increasing debt loads and facing harder decisions about what to do to solve them. The solution they keep coming up with is to print more money thus adding to inflation problem.The US government has only 3 policies print money, spend it, and borrow. They also keep interest rates at 0 percent, which is like adding gasoline on a raging fire. This has been the policy for decades. These are idiot policies and they are all coming back in a big way. The US government has not solved the financial crisis and will attempt to spend its way out of this one to an even greater extent.And lastly, we are going to end up in a great war because as more fiat governments fail they will attempt to plunder other countries to make up for idiot policies.All of this adds up to one thing, gold prices will go to the moon.

Posted by Mike | Report as abusive

Quoting Ben Bernanke on the economy is like quoting Hitler in August 1939 on the prospects of a German invasion into Poland. People are generally becoming less & less gullible. It was Bernanke & Co. that got us into this mess. By his own admission, it was the Federal Reserve that brought about the depression in the 1930’s. And we should believe him now?You give a lot of statistics & make it seem like a very complex issue. But it really isn’t as complex as you try to make it seem. It’s a simple matter of supply and demand of the dollar and the pound. As more dollars and pounds get printed, they become worth less and less. Where will people go to safeguard their wealth and savings? Government bonds from the same people that created the financial crisis they are attempting to get out of? Perhaps the stock market before it does another crash? No, it will be gold and silver because people will need something liquid of proven value through thick and thin.When the dollar crashes, gold will skyrocket into the stratosphere. I have read estimates from $2000 to $10,000. I don’t put any stock in those estimates as the forces causing it are too unpredictable. I don’t think anyone knows how high gold will go. But sure as the sun is coming up tomorrow, it won’t go down.What do you suppose would happen if the Fed had a stroke of inspiration and decided to back the dollar with gold? Would that stablize gold do you think? It did for 140 years from 1795 to 1935 when gold was $20 / oz.Gold & silver may well take a few dips as government attempts to suppress it to make themselves look good. But they don’t have enough gold & silver to do that over the long term.Why do write this nonsense? It puts Reuters in the same class of credibility as Bernanke, Obama and Geithner. No one believes anything they say about the economy anymore. Do you expect Reuters to fall into the same class of credibility?

Posted by Bill Goode | Report as abusive

Sorry Jane, I am with the others. You just do not understand what is happening here. For years, the price of gold has been capped and manipulated by some of the largest banks in the country. These banks called bullion banks, were able to squash little speculators like myself. But now, the governments of China and India, among others, understand that the US financial system is unsustainable. They are picking up all of the gold that they can with their soon to be devalued dollars. The big banks can no longer manipulate the price, because they will not be the ones to buy it back. To understand this, is to have the knowledge to actually make out in the futures market. However, I do this with a great deal of ambivalence because make no mistake, the price of gold will be inversely proportional to the level of pain in our great country, that has been so corrupted.Randy Epner

Posted by Randy Epner | Report as abusive

To the editor:I would just love to know what you considered unworthy of the post that I made about 15 minutes ago. I happen to know what I am talking about. And that information could be of significant value to your readers. So if you get a chance could you just drop me a note. Just very curious.Randy Epner

Posted by Randy Epner | Report as abusive

There is more to Gold price,than the mere inverse Dollar correlation.1.Why did Nixon remove the Dollar’s peg with Gold?The reports on the net will surprise any body,one argument being, that the USA “did not possess the same”,in sufficient amount.Now,the question arises:- where did this Gold go?2.Germany has recently asked the USA to return her Gold,and the UAE of the UK.3.There are many short positions in Gold Futures,which are, not backed,by PHYSICAL Gold,as per reports.4.US Federal Reserve has admitted that it had indulged in Gold swap.Britain sold, some Gold when the price was $250 per US Oz,when the present,British PM Mr Gordon Brown,was the Chancellor Of the Exchequer!Many other European banks have done the same,but in a business-wise, better way than Britain,but still at a loss,compared to the present price.5.THERE ARE REPORTS THAT IN HONGKONG,SOME “US” GOLD WAS CAUGHT PLATED WITH TUNGSTEN,AS THE DENSITIES OF BOTH ARE ALMOST THE SAME.6.It is very strange that the British PM proposed the sale of some IMF Gold,in the first G20 meeting regarding the so called,Global Financial Crisis!India has bought 200MT of the same.Has India been made a monkey of?The Nixon plan and many subsequent events,which include regulatory,political and economic, have formed a vicious cycle,and this is the reason Gold price is increasing:-someone needs a huge quantity of Gold or MONEY, urgently,by hook or crook!

Posted by sadasivan | Report as abusive

Correction:- Please read in item 5 of my post:-“salted with Tungsten”.

Posted by sadasivan | Report as abusive