Too much is happening in gold, too quickly, keeping the world in a fix. After a spellbound rally…we have seen sharpest correction in the last three trading sessions, which is sharpest correction since March 2008. In a single day's trading session gold saw a historical correction of $105 on Wednesday. So what next and what are the pros and cons affecting gold prices?
With its super performance in 2011, yellow metal gold has stunned the entire world. It has entered an uninterrupted 11-year bull run on rock solid fundamentals. If we talk about satisfaction for investors, it has already given a whopping return of more than 34% during 2011. With a brittle global economic recovery and precarious debt conditions in the United States and Europe, investors preferred parking their money in gold, which is considered one of the best safe haven buying opportunities. Now a days, it is on winning streak and making fresh highs now and then.
At present, investors are losing faith to some extent in any investment avenue that is directly related to the economic recovery. Abnormal monetary policy adopted in many countries and fiscal deficit problems have resulted in lackluster trade in currencies also. Most of the currencies are trading mixed on ambiguity in the market. Inflation is another concern for the market and lower interest rates in many countries will give an upper hand to gold. In this situation, gold is providing relief to the investors and so they are pouring money into it. Below are some positive as well as negative factors of gold having a crucial impact on the gold prices.
Negative outlook for major economies and the world economy: Downgrade of world as well as major world economies by major financial firms S&P, Goldman Sachs and Cit was the chief concern contributing to the recent meltdown in most of the investment avenues. Investors took shelter in gold, which is known as safe haven buying.
Strong physical buying: Despite higher prices, physical buying is steady. As per the World Gold Council, India and China together made up 57% of first-quarter global consumer demand for gold. China gold demand is expected to rise by 20% to near 700 tonnes this year from 570 tonnes in 2010. Ongoing festival season may also increase the demand for physical gold. Gold imports into India, the world’s biggest buyer of the yellow metal, jumped 60 per cent to 267 tonne in three months till June (first quarter).
Buying by Central banks: Recent gold buying by South Korea of 25 tonnes, also supported the upside movements. In 2010 central banks became net buyers of gold for the first time in 21 years owing to the ongoing uncertainty about the global growth and to diversify their foreign reserve. According to the World Gold Council, global central bank gold reserves rose by more than 900 tonnes over the nearly three years to June 2011. We can expect that even in 2011, central banks of different nations may go for further buying of gold.
Poor economic data: Economic data are giving serious concern to the market players. Poor housing, employment, PMI, GDP data have compelled investors to pull out their money from equities and currency and no doubt the major beneficiary is gold.
Bad performance by Equity, currency and other investments: With the fear of a further slowdown in economic activity and ineffective quantitative easing policies, investors are refraining from putting big money into these investment avenues. The recent meltdown has shaken fears. Investors won’t diversify their portfolios until unless they find concrete opportunities.
Pledge to keep the interest rate low: Recent assurances by major countries to keep interest rates at the lower end to fuel liquidity in the market is a buoyant factor for gold as gold has a normally negative correlation with the interest rate. The US will keep the interest rate unchanged until mid 2013 and China until 2012.
Seasonality: Generally September is the month when gold resumes its upward journey and it continues until December and January. This year we have seen the sharpest monthly rise in three decades in the month of August. Hence we don’t expect another significant rise in September. But buying at the dip should be good strategy because festival season has already knocked on the door of Asian countries and soon wedding demand will further impact the price of gold. Any dullness in equity markets may give more room for upside in bullion.
Gold de-hedging: Gold producer de-hedging activity eliminated 3.31 Moz (103 tons) in 2010, and the activity would continue in 2011 with net-dehedging forecasted at 1.41 Moz, according to GFMS Ltd. In the fourth quarter of 2010, producer de-hedging was recorded at 1.51 Moz (47 t), primarily as a result of AngloGold Ashanti’s October announcement that it had eliminated the remainder of its hedge book. Global gold hedging activity did an about-face in the second quarter of this year as the amount of gold being de-hedged by miners outpaced the amount being hedged. The global gold hedge book declined 0.9 million troy ounces to 4.2 million ounces in the second quarter, compared with a 0.3 million ounce increase in the first three months of the year.
Overstretched rally: In a short time span gold saw a hefty rise from $1,600 to $1,900 in COMEX and 21000-28000 in MCX. It’s too much, too fast and, in my opinion, will correct back to some extent in the near future before moving up. The rally is overstretched and we have seen the case of silver, which saw a roller coaster ride after touching the high of Rs.73600. In MCX it notched a razor sharp correction of more than 32%, a difficult time for investors as most of them didn’t have time to come out of their sell positions. In the same way gold is travelling north without any significant correction.
Margin hike: Margin hikes by exchanges will weigh on the gold rally. We already witnessed one round of margin hikes by exchanges; another will definitely limit the upside of gold. Hence investing in gold has become a pricey affair for investors now. Expect another soon, which could be a catalyst (as it was with silver).
Less participation by miners: Less participation by miners is indicating a narrow support by the core participants of this commodity.
Currently the world economy is surrounded with downbeat news, which is continuously sending gold prices into uncharted territory. Gold performs better in times of crisis but if the crisis is severe then even gold can see a sell-off as some participants have to sell their gold to pay debts.
Despite the correction in both international and national exchanges I would say that gold is still overpriced and a further correction is expected. Buying at the dip should be the prudent strategy for gold. In the Indian market, 25000-26000 is a good level to enter for mid- to long-term buying. In 2011, it may see an upside of 30000-32000 on ongoing festival demand. In COMEX, it may see another high of $2000 in 2011 and $1700 should be a good buying level for mid-term investors.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.