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R.E.G.B. Feeding Frenzy. What Are They Eating?

By Jon Nadler       Printer Friendly Version Bookmark and Share
May 27 2009 4:24PM

Good Afternoon,

Gold prices remained fairly firm near $950, but the day was otherwise lackluster in terms of price action. This, as (mild) dollar strength and tired-looking oil prices provided little in terms of additional impetus to spec funds. Oil is exerting all kinds of upward pressure on the commodities complex, even though its recent rally is not demand-based. Then again, neither is gold's, really.

At the present time, momentum fund participation, maintenance above the moving averages, and open interest numbers are helping in the additions to long positions. The lazy Wednesday afternoon session saw gold off by $1.50 at $950.50 -practically where it began the day. Silver, however, managed a nice gain on the day, and was last seen at $14.79 per ounce at 4:00 PM NY times. Platinum lost $2 at $1131, and palladium (don't ask why) fell $7 to $223 per ounce. Rhodium gained $5 to finish at $1300 even for the day. Equally inexplicably.

A gold breakout before June? Hard to imagine. The market is overbought. Where are the jitters? N. Korea did not do the trick (insofar as a $20+ move higher). What else will? GM? Don't think so. Its Ch. 11 filing is already baked into this market's price cake. Where is inflation? Still a speck on the horizon - except in Marc Faber's mind, as told below. Add it all up, and we see fund profit-taking as fairly imminent. The US dollar rose 0.21 to $80.30 on the index, while black gold advanced 73 cents to $62.18 per barrel. Nice and rich - just in time for the kick-off of the summer driving season. Said driving might not be done in spanking-new GM cars, however...

Urgent newsflash for the R.E.G.B. crowd! :Moody's Investors Service on Wednesday affirmed the AAA credit rating of the United States, assuaging fears about U.S. creditworthiness that have been creeping up in financial markets. The rating agency said the U.S. economy's long-term resilience and key role in global affairs should bolster its ability to resume a strong performance following the current recession. At the same time, the short-lived hysteria about the UK possibly losing its troika of As has also subsided since last week. A lot. Take a look at the credit rating map of Eastern Europe sometime. It's in the Economist. Do you think the US is Latvia? Or soon-to-be Moldova?

According to Forbes, with prices up roughly 32% on silver and more than 20% on palladium and platinum since the beginning of the year, gold's 9.4% price growth seems downright dim in comparison, making it the year's "worst" performer among precious metals. The news may seem surprising since investment interest in gold soared during 2009's first quarter with demand from exchange-traded funds hitting record highs, according to the World Gold Council.

High bullion prices, however, encouraged some selling and recycling, which tempered the metal's prices, and gold jewelry demand was much weaker during the period as a result of the global economic crisis. The greatest contributing factor to gold's weakness is likely much less complicated, according to analysts. Silver, palladium and platinum are simply playing catch-up. And, since we are on the subject of catching up (with fantasy levels, that is,) here is Forbes on the markets:

"Gold at $5,000 an ounce? Most don't believe it, but the gold bugs do. [Radical Extremist Gold Bugs, that is.]

Given the large question mark looming over the global financial markets, it's hardly surprising that there's been a recent infestation of gold bugs. Despite the frequent unveiling of economic stimulus measures throughout the world and equity markets gradually creeping higher, investors' increased interest in buying physical bullion is a testament to gold's appeal as a hedge against currency devaluation. 

"Surging investor demand is powering the gold market," said Citi global commodity strategist Alan Heap. "The market is expected to remain robust as long as economic and financial risks remain paramount. But it's a crowded trade and fundamentals are not supportive." According to a World Gold Council's report released Wednesday, gold demand rose 38%, to 1,016 metric tons in the first-quarter from last year, representing a 36% rise in value to $29.7 billion. The bulk of growth, however, come from gold-backed exchange-traded funds, gold coins and bars--products that are popular among precious metal hoarders.

Gold investment demand as gauged by increased holdings of exchange-traded funds, bars and coins, rose 248%, to 596 metric tons, year-over-year with a record investment into ETFs: up 540%, to 465 metric tons. Gold jewelry demand, meanwhile, slipped 24% as a result of high gold prices and downturns in consumer spending. India, typically the biggest consumer of gold, recorded a 83% drop in demand from a year ago, while China showed 3% growth in bauble buying. Global recessionary conditions also weighed on the electronics sector and industrial demand fell 31% from 2008's first quarter.

"There has been a seismic shift away from capital appreciation towards wealth preservation and we believe this trend will define investment behavior in the next decade," said Aram Shishmanian, chief executive of the World Gold Council.

[contrasted by]:

"On a historical basis, gold is overvalued at the dollar's current level, says Joel Crane, vice president of global commodities research at Deutsche Bank, making it "ripe for a correction."

Crane sees gold at $920 an ounce in the third quarter and at $850 an ounce in the fourth quarter, barring unexpected weakness in the U.S. dollar and/or equity markets. It's been trading around $940 lately. Still, gold ignites passions and its most faithful adherents believe that the worst of the world's economic turmoil is yet to come and predict that gold prices will have no difficulty surpassing March 2008's record of $1033.90 an ounce.

"I do believe that we're going to have a significant downward drop across U.S. markets that's going to occur in the third or fourth quarter of this year once people see that government efforts to resurrect the banks won't work to the degree that they're expecting them to," said Dan Deighan, founder and president of Deighan Financial Advisors. "It'll be a hard crash that'll drop past the lows we experienced last fall and it'll really shake people up."

05/27/2009 12:38PM ET

intraday: GLD

SPDR Gold Trust (GLD)

Deighan is skeptical that consumers will suddenly start spending given high unemployment rates and baby boomers' weakened retirement portfolios. He also worries that the U.S.'s high level of unfunded future liabilities will be deleterious to its creditworthiness, making it more difficult to find buyers for its mounting debt. "The level of fear is going to pale in comparison to earlier fear and we're going to see the value of gold go up significantly," Deighan said. He says he's heard gold forecasts ranging from $1500 to $5000 an ounce in certain investment circles that he declined to identify.

Even if gold doesn't push past $1000 in the near-term--and most analysts don't think that it will--bullion is still a good buy in Deighan's eyes since he treats investment in gold coins as an insurance policy against inflation. "Even if gold prices fall, it's like paying an insurance premium. We didn't have the currency weakness, so it was just an insurance policy against the possibility of a currency devaluation. While we do think it gold will go up in value, it's okay if it doesn't."

"Currently, people have very divergent views on where the U.S. dollar is going to go," Crane said, by way of accounting for varying price forecasts on the precious metal. "Economic theory suggests that the U.S. dollar will get weaker but people are questioning which currency it'll weaken against since central banks all over the world are dealing with the same issues."

Crane thinks the increased availability of safe haven alternatives to gold have tempered the precious metal's prices.

"To me, the most surprising aspect of this current crisis is that gold prices didn't rally to extreme levels," Crane said. "If you had told me before about the type of crisis that was about to unfold, I'd have thought gold would have hit $2000 an ounce. Part of that has got to be because there are other hedges against inflation now that people can enter that weren't as available in past times of economic and social turmoil."

Still, Citi analyst Alexander Hacking considers gold a crowded trade. In the short-term, he expects a pull-back to $850 an ounce and doesn't see the possibility of an inflation-driven rally pushing gold past $1000 an ounce until late 2010 at the earliest, according to a recent note."

" I see...the need for some seriously thick fortune-reading eyeglasses in my own future"

Other fortune-telling pronouncements from no less than two Doctors (of) Doom were set loose in this morning's news flows. Nouriel Roubini, the 'original' Dr. Doom, declared that the US slump will end before this year runs out. He sees interim hiccups such as 10% unemployment, and a stock market rally that will not endure, but he sees a recovery nonetheless. Marc Faber, who adds "Gloom" and "Boom" to his doctoral degree of Doom, envisions (with no less than 100% certainty!) the USA turning into Zimbabwe as far as inflation is concerned.

How about, neither of them will turn out to be correct? It is more than plausible that we will not get a US recovery until well into 2010, and that when we do see inflation returning, it will be one of a moderate type, as well as one that prompts tax and interest rate action by the Fed? We've only met one economist who was 80% correct all these years - the one who reserved the right to change his mind 50% of the time.

Thus, his batting average was very much in line with the rest of the league of pundits. And, of course, the guy who got it completely right, is actually a gal. She is not known for her credentials, she is not known for what she predicted, and, she has long ago retired to an island on that single bet. Someday, she might write a book. But, don't count on it. Such things are normally not meant to be shared.

More crystal-ball gazing was on offer this morning as regards gold and its future price prospects. Not to sound repetitive, but price is not the issue for the majority of holders we speak to. In fact, stability is more of a concern/desire. But, as you can see, opinion is neither in short supply, nor very does it exhibit homogeneity. At all. First, the extreme views. Much like a scene from "Religulous." - no possible peaceful coexistence of views here:

"THE basic premise is not new, but then nothing’s changed much... Ludwig von Mises, the father of Austrian economics, who recognised early on that government attempts to massage the credit cycle always end in tears, memorably described the phenomenon as follows: “There is no means of avoiding the final collapse of a boom expansion brought about by credit expansion. The alternative is only whether the crisis should come sooner as the result of a voluntary abandonment of further credit expansion, or later as a final and total catastrophe of the currency system involved.?

The “final and total catastrophe of the currency system?, is in this case the dollar. If you believe that’s where we are headed then gold still has some way to go. To believe it doesn’t is to believe the worst is pretty much over, that the excesses have all been unwound, that the central banks have triumphed, that paper currencies have won the day… without threat of inflation.

What about deflation? All over the world the central bankers’ reaction to the threat of a slowdown has been the same: print more money, slash interest rates, find ways to stimulate. If the patient is going to die, even the most radical course of action is better than doing nothing. Most paper currencies will suffer the consequences." - could be authored by Ludwig von Mises and/or Marc Faber - take your pick.


"The gold ETF (GLD) is the 6th largest holder of gold in the world - the whole world, even ahead of China.  When investors buy GLD they have to go out and buy gold driving up the prices. This raises a little question - who will be buying this gold from GLD when investors will decide to sell it? Gold is one of those weird assets where nobody knows what it is really worth. You cannot run discounted cash flow analysis to value it - it has no cash flows. It is an asset where perception and reality are deeply intertwined.

Investors buying the gold ETF (GLD) are influencing the price of gold which is fair for the most part as otherwise they’d be buying the real thing. Though of course the ease of buying GLD creates a slightly higher artificial demand, but still it is fair game.  The violent sell off in GLD will drive the prices of gold down dramatically unless a real buyer steps in (like another government sick of owning the US debt for instance) and the gold price could get cut in half overnight. Suddenly perception of not being a store of value will create a reality of gold not being a store of value. The gold game will be over." - was penned by Vitaly Katsenelson. Not a household name, but a correct assessment of the reality of a market with the GLD present in it.

Any room for the 'middle' road? Yes, but who is listening?

Looking ahead, the question for gold investors is whether investment flows this year will prove powerful enough to overcome the drag effect on the gold price of counter currents.

The WGC, in its Gold Investment Digest for the first quarter, noted that a prominent theme for investors was the outlook for price stability: opinion appeared divided between those concerned about the prospect of inflation and a smaller number worried about deflation.

Charles Gibson, an analyst with Edison Investment Research, says there are lessons to learn from the 1970s, a decade where structural trade deficits, burgeoning budget deficits and bank failures were prominent too. As then, the authorities are reacting to debt deflation with a stimulative monetary policy: “History suggests they will probably overdo it?.

In the 1970s, the result was a runaway wage-price spiral and a second peak in inflation later in the decade. As a result, gold rose from $35/oz to $850/oz in 1980 – a 24-fold increase in value. Though he does not expect such a dramatic increase in the current era, he forecasts that a repeat of the same cycle would see gold averaging more than $1000/oz over the next 21 years, with a short-term peak of $1,567/oz as investors again seek a hedge against inflation.

Gibson’s analysis, detailed in a recent report, assumes the continuation of very low and/or negative real American interest rates and a relatively well-supported oil price. In particular, he argues that negative real interest rates disrupts the mechanism by which the bullion banks lease gold from central banks, leading to a squeeze on supply from producer hedging.

Could the slump in jewellery demand hold back the gold price? It could do, says Gibson, but during similar periods in the past, the increase in investment demand has always outpaced the decline in jewellery. In fact, he suspects that if inflation is seen as a problem, investors will rush into jewellery as much as they have piled into gold ETFs, bars and coins. “Gold is sailing and the wind is behind it,? he says.

Michael Lewis of Deutsche Bank takes a more neutral view on the outlook for the gold price: “Gold is probably the most richly priced commodity in the world at the moment: in real terms, it’s trading at around 65% above its long-run historical average.? This represents a significant premium to many other commodities.

For the gold ETFs, the main threat would be dollar strength, he says. However, any change in the outlook for the gold price over the short term would be more likely to be to the upside, linked to further weakness in the dollar.

However, Lewis views the risk of inflation to be low, at least for the next couple of years, because of the large output gap in America and the likelihood of weak economic growth persisting in 2010 and 2011. Only when the global economy starts to recover strongly are inflationary risks likely to emerge. Instead, the global economy is likely to remain in a disinflationary environment: this is a relatively benign scenario for gold as it keeps real interest rates low and allows gold to compete aggressively for risk capital. “What gold really needs to worry about is deflation,? he adds, as real interest rates would rise. However, he expects the global economy to avoid this outcome.

In contrast, Wozniak argues that persistent deflation could underpin the gold price as it would enhance the yellow metal’s safe haven status.

Dan Smith is fairly bullish about the gold outlook: he expects investor inflows to remain strong for long-term reasons and the dollar to weaken significantly before the end of 2009. Though Standard Chartered expects economies to suffer deflation in the short term, Smith does not expect this to have much impact on the gold price.

GFMS comes down firmly on the side of the bulls. It argues the $26 billion that entered the gold market last year – a relatively small amount of money compared to the regular flows into mainstream asset classes – could be dwarfed by the flows into the yellow metal this year if gold’s appeal widens substantially because of investors’ growing concern at western governments’ and central banks’ willingness to attempt an inflationary solution to the current global economic crisis.

Sierra Highcloud of GFMS comments: “There are many blips and corrections in every bull cycle, yet we believe that over the course of this year prices will, overall, remain well supported, if not move to fresh all-time highs?.

The bull market may have further to go – but investors may be in for a choppy ride."

Thus, we come to our own forecast: the gold price will.....change. It will go up, then down, then up again. Followed by more downside action, which in turn will be followed by moves to the upside. And, so on.

As for the one-way street (in either direction)? You might as well hang that one up. We predict. With 100% certainty. And with the right to change our mind half the time.

Still, the nearly-lost-in-this-deluge-of-prognostications tiny little observation that the metal is trading some 65% above its long-term historical average, keeps nagging us...

Jon Nadler
Senior Analyst
Kitco Bullion Dealers Montreal



Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in precious metal products, commodities, securities or other financial instruments. Kitco Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.