Commodities | Dec 21 2009
By Andrew Nelson
On all accounts it has been a good year for gold, with the price shooting to a record high of US$1,226 an ounce by the beginning of this month. Since then its has come off a bit, finishing last week at $1,110, but gold has none the less been one of the star performers of the past decade, its price having increased by more than 300% since the end of 1999.
One of the main driving forces of gold’s ascendency has been the appetite of private investors, who have moved to buy in en masse over the last year in a move to build a hedge against the global financial crisis, the weakening US dollar and inflation fears as central banks around the world carry on printing money.
The best evidence of this increasing consumer desire to own gold is the growing demand for 1-ounce American Eagles, the world’s most popular gold coin. The US Mint simply ran out last month. Another sign is the fact that gold bars can now be bought at Harrods, with the department store recently saying that demand has been well above expectations.
However, it is starting to look like the tide is beginning to turn, with half of the fund managers surveyed for last week’s Bank of America Merrill Lynch Global Research report saying gold was now overvalued and would fall next year. Leading the call for weakening gold is market doyen Nouriel Roubini, who warned that gold now faces the risk of a major downward correction.
Roubini argues that the recent rise in gold prices is only partially justified by fundamentals, thus it is a “bubble that could easily burst”. He also said that there are few reasons that could justify a rise in bullion prices to toward $2,000 an ounce in the foreseeable future. That is unless the world begins a period of high inflation or slips into a depression.
The good news is: Roubini thinks neither case is likely.
Yet there is still a large number of analysts that remain positive gold will continue to rise. Their argument is based on what are seen as being some strong market fundamentals. One of the main factors is struggling production, which has fallen 8.7% since its peak in 2001. A combination of continued credit risk, US dollar weakness and commodity market strength is seen as another supporting factor.
There is also the more basic argument that gold simply isn’t overpriced when compared with its own previous highs in real, inflation-adjusted terms. Based on such adjusted numbers, gold hit a high of US$2,200 an ounce in 1980, so it still has a long way it could run.
While exchange-traded funds that follow the gold price have been a pretty popular way for private investors to play the metal, with US$80 billion now invested, gold miners are starting to grab more attention, as their share prices have continued to trail the rise in the gold price. In fact, the past three years have seen the FTSE Gold Mines index underperform the gold price by 22%.
On the other hand, there is a growing number of analysts and market commentators like Roubini who not only believe gold’s run is unlikely to continue at this year’s break neck pace next year, the metal is set to fall.
One argument is that many were buying gold as a sort of insurance against catastrophe, yet there are fewer and fewer who now believe that a catastrophe is going to happen. And in fact, now that we are facing what appears to be a recovery, many investors are likely to become increasingly aware of the fact that gold doesn’t pay a dividend.
And if the past month or so is anything to go by, the US dollar may not fall nearly as much as many have been predicting. This is likely taking even more shine off the metal as a hedge against a falling greenback. It is becoming all the more obvious that global growth is on the road to recovery, putting memories of the Lehman collapse and what followed far behind them.
With recovery, even in the US, on the cards, stronger US growth will eventually force a shift in US central bank policy, probably some time during the first half of the year ahead. This, in turn, should reverse the greenback’s decline and cause gold to weaken in the second half of 2010.
On top of this, it appears that China and South Korea, two of the countries that have been the most enthusiastic buyers of gold this year, are starting to grumble about prices being too high.
An article in the Times of London over the weekend [Where next for the soaring price of gold?] polled a number of sources about where they though gold would go next year. The paper notes Bill O’Neill at Merrill Lynch Wealth Management thinks bullion will hit US$1,500/oz in the next 18 months, citing a cocktail of ongoing credit risk, continued US dollar weakness and general commodity market strength.
On the other side of the fence, the article notes Julian Jessop at Capital Economics believes prices will fall to US$950 by the end of 2010 as the US dollar recovers. The paper also notes that Adrian Lowcock of Bestinvest thinks gold could well hit US$850/oz by the end of next year.
Lastly, the Times cites Stuart Thomson from Ignis Asset Management, who believes that while the gold price will continue to rise throughout the first quarter of next year, peaking at close to US$1,250/oz, it will then drop back to US$985/oz by the end of 2010. In the words of Thomson: “In a world of heightened macroeconomic volatility, gold bugs will have to be nimble to prosper in 2010.”