Gold bugs and humbugs collide

Reuters | Wed, 03 Jun 2009 10:17
[miningmx.com] -- With gold poised to lurch above $1,000 an ounce for a third time, the lines are being drawn between bulls who believe a dollar-hedging rally has only just begun and bears who say four-digit bullion will be fleeting.

Fuelled by expectations of growing inflation after aggressive government pump-priming measures around the world to help prevent major economies from falling deeper into recession, spot gold prices have risen 14 percent in two months.

At 0654 GMT on Wednesday, prices were up nearly 1 percent at almost $990 an ounce, within sight of the $1,000 mark first hit in March 2008 and last touched on Feb. 20. Despite briefly trading in four-digit territory on three separate days, prices have closed above the mark only once, on March 17, 2008.

Big bulls say expectations of further dollar weakness, a recovery in stocks that has bolstered investment funds' purchasing power, and concerns about the inflation outlook should help drive the spot market into uncharted territory beyond the $1,030.80 intraday record high touched last year.

But bears cast doubt on the sustainability of gold buying, saying the dollar's current weakness is tied to too much optimism about the economic and financial outlook and that other fundamental factors will put a lid on gains.

Hedging against inflation

While gold's rally late last year and early this year was fuelled by financial insecurity and justified fears of recession, the latest leg-up has been driven by concerns that the dollar may slide further as investor risk appetite improves on growing signs that the global economy has emerged from its worst state.

Yukiji Sonoda, an adviser to Daiichi Commodities Co in Tokyo, said gold could quickly rise to a record high $1,100 an ounce on its way to $1,300 an ounce within the next few months.

Concerns about the risk of the U.S. sovereign rating losing its triple-A status on a ballooning budget deficit and its future as a reserve currency have also weighed on the currency.

"If I look at 10 years from now, I do believe that the purchasing power of the dollar is going to be substantially less. Gold is ... the simplest way to play the devaluation of the dollar and potential inflation," said Axel Merk, portfolio manager of California-based Merk Hard and Asian Currency Funds.

The benchmark 10-year U.S. Treasury yield rose to 3.75 percent last month, its highest since mid-November, while the two-year and 10-year yield spread widened to a record 277 basis points this week. Rising yields spur lending and bolster economic activities while sowing the seeds of inflation.

Central banks tend to lag in raising rates for fear of stifling the recovery, making gold a safe haven against inflation. For now, major central banks are widely expected to keep interest rates at current low levels for much of next year, but ample funds currently available call for future aggressive tightening.

"Although growing investor risk appetite has undermined so-called 'safe-haven' demand for gold, expectations of a period of strong reflation has raised the investment appeal of commodities including gold," says Toby Hassall, chief analyst at Commodity Warrants Australia in Sydney, who sees a "reasonably high chance" for gold to keep gaining beyond $1,000.

Return of the fundamentals

Bears say the current rise in gold prices is primarily driven by speculative buying and fears of an inflation surge that may not materialise for years, and question the idea that dollar anxiety will keep growing, driving investment non-dollar assets.

"Gold's strength is unnatural and $1,000 is overshooting, based on very short-term technical factors driven by trend followers," said Wakako Harada, senior trader at Mitsubishi Corp.

"Even given all the problems the United States has, I don't think investors will totally shun the dollar," she said, adding that the latest bout of dollar selling was due for a correction.

They also argue that the same fundamentals that have impeded gold's past attempts to sustain four-digit gains will come to the fore again: scrap selling from major consumers such as China, India, Southeast Asia and the Middle East; reduced demand for jewellery as high prices dampen consumer buying.

"It's difficult to sustain a rise above $1,000 because it is not accompanied by real demand," says Yuichi Ikemizu, Tokyo branch manager at Standard Bank Plc.

"It doesn't make sense that gold is at current levels when stocks are rising on hopes for economic recovery."

He said there is inconsistency with the rising trend in gold, which typically draws support from investors seeking safe havens, and the VIX index, the key gauge of market volatility, falling to levels not seen since the collapse of Lehman Brothers.

Based on U.S. CFTC futures-options data, speculators' holdings amounted to more than 700 tonnes, says Ikemizu, and past patterns showed gold hit $1,000 when speculators' long positions reached 850 tonnes, and prices reversed and fell.

And should economic data continue to show steady gains, thwarting expectations of a likely slow rebound, gold prices could quickly come under renewed pressure.

"This year not only will we see some positive surprise on the production side -- production will be increasing due to higher prices -- and on the demand side, we will probably be negatively surprised by weak jewellery demand," said Eugen Weinberg, an analyst at Commerzbank in Frankfurt.