Gold: A healthy correction or a bubble bursting?
By: Jeffrey Nichols
On November 9, 2010, as gold was registering new all-time highs near $1,425 an ounce, we warned the metal was "certainly vulnerable to a setback, and a substantial one at that."
In part, we thought that the influx of speculative buying that contributed to the upward spike over $1,400 would inevitably lead to profit taking. And, indeed, it did. From it's all-time high early last week, gold shed as much as $70 an ounce, trading at times under $1,360.
But there is more to the story of gold's latest up and down . . . and more to suggest that gold's strong upward price trend will soon resume:
FIRST, MARKET REACTION TO THE WORLD BANK STATEMENT ON GOLD
Fueling gold's ascent early last week was an op-ed article by World Bank president Robert Zoellick in Monday's prestigious Financial Times suggesting the leading economic powers consider making gold part of a new "cooperative monetary system." Gold bugs and much of the financial media jumped on the news, believing that the World Bank was suddenly advocating a return to the gold standard.
But a more objective reading revealed Zoellick suggested gold might merely serve as an indicator for relative currency valuation within some new global monetary system. This is a far cry from re-monetization of gold, which seems unworkable to us, and implementation of a gold-centric world monetary order. Just as quickly as they jumped into gold, many investors and speculators speedily exited once they understand the very limited and, indeed, rather peripheral role for gold suggested by the World Bank.
SECOND, RENEWED EUROZONE SOVEREIGN DEBT WORRIES
Rising concerns in the past week about Eurozone sovereign debt once again triggered a flight from the euro, Europe's single currency, to the relatively safer U.S. dollar. And, in true reflex fashion, the dollar's appreciation against the euro, also contributed to the weaker dollar-denominated gold price.
Although gold is the ultimate safe haven in times of financial risk, many institutional investors and speculators still remain uncomfortable with gold, prefer interest-bearing assets even at low rates of return, and believe the much greater size of global currency and fixed-income markets (relative to a much smaller world gold market) will assure speedy and efficient trading in and out of positions.
But flight from the euro to the U.S. dollar can weigh on gold prices only so long. As we've seen in the past, risk aversion will push the dollar up only so far against gold. If euro risks continue to rise, we will see still stronger retail demand for physical gold in Europe and elsewhere have a more powerful positive effect on the yellow metal's price. And, if euro risks abate, we can expect gold to benefit from a renewed fall in the U.S. dollar.
THIRD, CHINA'S INTEREST RATE OUTLOOK
Compounding gold's troubles late last week were rumors that China's central bank, the People's Bank of China or PBOC, would soon raise short-term interest rates or take other restrictive monetary policy actions to counter rising domestic price inflation, help deflate overvalued equity and real estate markets and prevent the economy from overheating.
Negative reaction hammered equity prices on the Shanghai Stock Exchange and other regional equity markets. Gold prices were also hit hard by the rumors of PBOC tightening. China, of course, vies with India as the biggest national gold market. Rising demand for both gold jewelry and investment has been an important bullish force on the world gold market and has contributed significantly to the metal's impressive appreciation in recent years.
China's gold market depends importantly on continued economic growth, rising household income and a growing middle class in that country. Prudent actions now -- including a gradual upward adjustment in interest rates and a continued gradual appreciation in the yuan, China's currency -- will contribute to healthy, long-term, economic expansion and this is the best scenario for continued growth in gold jewelry and investment demand.
FOURTH, PHYSICAL MARKETS REMAIN ROBUST
Physical demand in key world gold markets, especially China, India and other Southeast Asian trading centers, remained remarkably firm in recent weeks. Earlier this year, and certainly last year, the idea that physical demand could remain firm with gold trading in the $1,300 to $1,400 an ounce price range seemed totally inconceivable to most market analysts and participants.
As in the past, when gold prices hit the big round numbers -- $1000, $1100, $1200 and $1300 -- many expected widespread physical selling and an outflow of old gold scrap from these local markets. But now, even with prices near $1,400 an ounce, we have seen a persistence of physical demand and only limited quantities of old scrap coming back to the world market.
This suggests not only a continuing price appreciation and revaluation of gold -- but also a mental re-evaluation or upward adjustment in expectations of many gold-market participants about the current and future price of gold.
If physical buying remains fairly firm -- and, even more so, if demand responds positively to the lower price levels of recent days -- we can expect that gold will soon be soaring to new all-time highs.
REALLY, NOTHING IS CHANGED
As of November 15, 2010, while a few misguided souls are already pronouncing the death of gold, believing the current correction signals an end to the bull market, we remain confident in our long-standing forecast of still much higher prices ahead.
Indeed, we have often warned that extreme two-way price volatility would persist as gold continues its great upward march -- first to $2,000 an ounce, then to $3,000, and probably still higher in the years ahead.
Really, nothing has much changed as we come to the end of the tenth consecutive year of rising gold prices.
The key bullish points (U.S. monetary policy and the absence of any cohesive fiscal policy; the long-term on-going devaluation of the dollar and its diminishing appeal as a reserve asset by many a growing number of central banks; net official sector demand as more central banks buy gold; healthy rates of economic growth and growing demand for gold jewelry and investment in the China and India; rising investor interest from both retail and institutional investors; the development of new gold-investment products and geographic markets; continuing sovereign risk issues for a number of European nations and the diminishing appeal of the euro as an international currency; and little if any growth in world gold mine output for years to come) that have long supported our bullish outlook for gold remain as valid today, if not more so, than ever before.
Jeffrey Nichols, is Managing Director of American Precious Metals Advisors (www.nicholsongold.com) and Senior Economic Advisor to Rosland Capital (www.RoslandCapital.com ), and has been a leading precious metals economist for over 25 years.
Posted Tuesday, November 16 2010