Gold's bullishness still intact despite the correction in market - Emirates24|7

Gold's bullishness still intact despite the correction in market

We are now in the middle of a correction of a great bull run in gold that had been beating gravity right from mid-August 2007.

From the highs of $1,030 seen on March 17, gold is now trading almost 17 per cent lower at around $850 at the time of writing. With most fundamentals intact and bullishness creeping in from multiple sides, investors are perplexed over the sudden change in trend in the market especially in the last two months. Having reached critical support levels on the charts, it is time to have a look again at fundamentals to assess what could drive gold higher in the coming months.

A look at the long-term charts after the recent slide hints gold's uptrend seems to be intact and what we see at the moment is largely only a correction or consolidation in a long term bull market. Gold production is slipping – mine production is now at an 11-year low, mainly due to low investments in times of low prices. Productions costs are rising reflecting the sharp rise in crude oil and lack of skilled work force. Over the last couple of years production costs has surged by roughly 25 per cent to $500 (Dh1,835) per ounce.

Meanwhile, investment demand has been surging at a faster than expected pace, largely fuelled by the availability of easier investment options such as gold exchange traded funds (ETFs). The total amount gold in the ETFs now roughly stands at 772 tonnes – far higher than the total gold reserves of Japan. Today, the total value of investments in ETFs is around $21.5 billion, compared to just $1.5bn in January 2005. That's a smart rise of nearly 1,300 per cent in just over three years. This investment demand could cushion any major slide in metals.

Jewellery demand has slowed after the swift price rise in the last quarter of 2007 and has started to show a resurgence, with most consumers recognising higher prices are here to stay. With demand inversely correlated with price, demand could surge as prices stabilises above $820-$840/oz.

The US dollar is under severe pressure and there are few fundamentals to support it from a further loss of value on foreign exchange markets other than looking "cheap". The current downtrend in dollar hints the loss of value is no longer just cyclical phenomenon and is increasingly appearing to represent a permanent loss of value against its peers. From the start of the year, dollar has lost almost 10 per cent of its value against the euro and about of eight per cent against a basket of currencies on the dollar index.

In the coming months there could be a marginal bounce back in the dollar, but the perils of US economy are unlikely to get dissolved soon. Gold normally moves in the opposite direction to the US currency which, when it rises, makes dollar-based commodities, such as gold, silver and oil, more expensive for holders of other currencies.

In recent years, mining companies have increasingly reduced hedges to take advantage of the rising bullion prices. Gold mining companies are generally seen to be short on futures market to hedge their price risk, but if mining companies are increasingly reducing their hedge positions, it means they want to take advantage of the rising bullion prices.

As the major sellers get out of way, gold's uptrend path will start getting easier. During 2007, producer de-hedging rose by nine per cent adding 446 tonnes to the total demand. Despite this reduction in the volume of the hedge book, the aggressive price rally in gold over the last six months has deteriorated about $9.4bn from the producers' profit due to mark-to-market losses in their short futures positions.

The bullish arguments for crude oil are quite evident and the prices trading above the $110 mark are indication of the digestion of these facts by consumers and producers alike. Going by standard correlations, higher crude oil prices stokes inflation fears and gold is often considered as an inflation hedge. The correlation between crude oil and gold has been at least 90 per cent over the past 10 years.

On the negative side of fundamentals, a gold uptrend could face few blockades if central banks or the International Monetary Fund (IMF) attempts to sell to sell gold in order to keep the perceived value of paper currencies intact. Aggressive rise in gold has the potential to de-stabilise the entire monetary system. Quite recently IMF had proposed a sale of more than 400 tonnes of its gold supplies. But the sale cannot occur without US congressional approval as well as legislative action in many of the 184 other nations that are members of the IMF. This does not mean that central banks of various nations would stay calm if there is a threat to the monetary system. Experts believe central banks still own more than 31,423 tonnes gold, enough to check any aggressive rise.

Having lost more than 17 per cent of recent gains, gold still carries enough bearish bias and it is prudent to be cautious at these levels. While physical demand supported by cultural and religious traditions, which are not directly linked to global economic trends may continue to support gold's bull trend, a surprise rise in dollar or central banks' sales could keep a lid on aggressive surge. Going ahead, if gold could hold above $820-$840 levels, sustained gains are on board.

However, gains beyond $1,030 ounce again are likely to be delayed at least till the third quarter of this year. In the long term, gold could reach at least $1,100, but beyond that fresh fundamental surprises would be needed.

From here on gold is likely to take a scenic serpentine road that has not been seen since August 2007 and it will good to remember that bull markets aren't without wrinkles.

The author is assistant vice-president on the research and trading desk of Vision Commodities Services.
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