Insights

Gold struggles to find footing

Long-term price outlook higher
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By Jeffrey Nichols
Published : 09/28/11
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Ever since hitting its all-time record high of more than $1,923 an ounce on Sept. 6, gold has had tough going as it struggles to find firm footing in the $1,770 to $1,830 price range.

Ironically, uncertainty over Europe’s sovereign debt mess — with Greece seemingly hurtling toward bankruptcy and rising anxieties over Italy’s mountain of debt — has hit gold the hardest.

Not only is the viability of Europe’s common currency, the euro, threatened by disarray among Eurozone member countries, but some of the major banks on the continent that hold Greek debt face insolvency if Greece defaults.

Ordinarily, investors and analysts might expect prospects of this sort to send gold prices rocketing skyward — but this has not yet been the case. Instead, Europe’s worsening debt disease has triggered so-called safe haven demand for the U.S. dollar and boosted the greenback’s exchange rate against the euro, to gold’s detriment.

Institutional speculators trading in futures and other derivative markets, guided by technical signals and program trading models, have also contributed to gold’s recent price action — both up and down. At higher price levels over $1,900 an ounce, CFTC Commitment of Traders reports indicated that “long” positions were excessive — and once selling began, the race to “short” gold quickly drove the metal’s price down.

Of particular interest of late has been the widespread and geographically diverse firmness of physical demand — that is, demand for investment-grade jewelry, bullion bars and coins.

Investors and consumers in India and China, the world’s two largest gold-consuming markets, continued buying even as gold zoomed over $1,900 an ounce. It is noteworthy that the Indian market, which historically has exhibited a great deal of price sensitivity, hardly paused at $1,900 an ounce. In past years, Indian demand typically slowed — and even reversed — as many investors took profits, selling gold back into the market.

The continuing rise in household incomes in tandem with worrisome inflation is driving demand, in India, China and elsewhere in Asia. This is unlikely to change in the foreseeable future.

Retail and high net worth investors in Europe and the United States have also continued buying gold — mostly small bars, bullion coins and exchange-traded funds — even as gold registered new historic highs. Demand in these regions has been and continues to be fueled by political and economic-policy disarray — in Europe over the Eurozone debt crisis and in the United States by Washington’s inability to deal effectively with growing high unemployment and huge federal budget deficits.

In addition to firm private sector gold demand, the official sector has been an important buyer, with a growing number of first-time buyers, like South Korea, adding gold to their monetary reserves, and others, led by Russia and China, buying gold monthly or on price dips.

With both the U.S. dollar and the euro looking tarnished and risky to central bank reserve managers, official sector gold acquisitions are likely to continue.

Importantly, to the gold-price outlook, today’s buyers, both private investors and central banks, are likely to be long-term holders. Much of this gold, once bought, is unlikely to be resold anytime soon, even at much higher price levels. For central banks, the holding period will be measured in decades if not longer. This promises less liquidity, more volatility and much higher prices in the years ahead.

Jeffrey Nichols is a recognized expert on the economics of precious metals markets. He is managing director of American Precious Metals Advisors (www.NicholsOnGold.com) and also serves as senior economic advisor to Rosland Capital LLC (www.RoslandCapital.com), a retail dealer of precious metals investments and numismatic coins. Follow Jeff Nichols on Twitter @ NicholsOnGold.

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