Negative fundamentals look set to propel gold higher
In US dollar terms, gold prices have been in retreat since late last year despite the world being in the grips of the worst financial crisis since the thirties and with little end in sight. Yet, gold often moves in tandem with other risk assets such as equities and commodities.
So has gold's decade long bull run finally come to a close? Probably not. Central banks can have an enormous influence on the price of gold given their massive financial fire power – and recently they have been net buyers of the yellow metal. According to the World Gold Council net central bank purchases in 2011 exceeded 455 tonnes with emerging market ones leading the way. The WGC noted that gold made up a total of 12.8% of central bank reserves at the end of March 2012, up from 9.7% at the end of 2008. Some twelve countries have over half their reserves in gold, compared with seven at the end of 2008. And many experts expect those trends to continue.
For the gold bulls - it gets better. Metal Economics Group found that gold production is not keeping pace with production. Discoveries made between 1997-2011 may potentially only replace 56% of the estimated gold mined during that period.
But the big catalyst the market is waiting for to reignite the gold rally is for the US Federal Reserve to do another round of money creation or its third quantitative easing programme. Analysts think this is a dead certainty and just a matter of time as the US economy is slowing and as the Eurozone crisis lurches from bad to worse
But if this is such a sure thing then why isn't the market buying gold in anticipation of QE3? Many other countries have already been loosening monetary policy and that didn't move the dial much on gold prices. The implication is that the market is focussing on something else, which suggests gold may not rally that strongly once the Fed does announce QE
And that something else could be deflation, not an ideal condition for gold prices. All the monetary stimulus that has occurred so far has come nowhere near to triggering a serious inflationary shock. QE3 may well push commodity prices up as have the other QE rounds, but it seems it is unlikely that it will cause anything like a burst of seventies style inflation. Quite simply all this new money from central banks, just seems to end up back at the central bank or parked in high grade government bonds rather than in the real economy. Also, some economists are warning that the next round of QE may be less effective than the last in pumping up the markets.
What may rekindle the gold rally is growing concern over the creditworthiness of governments in the US, Europe and Japan as the budget deficits pile up with little hope of them being paid down due to lacklustre economic growth. At some point investors may worry over the ability of the US government to carry on servicing its huge debts and could become unnerved if the Fed was, for instance, to start printing money to pay the interest bill. Indeed, gold is sometimes described as a bet against humanity and right now the global economy is in an awful state and it looks set to get worse before it gets better. So extreme fear rather than inflation might become gold's best friend.
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