By Greg Peel
The priceof gold rallied in the US on Wednesday on a weaker US dollar, a strongoil price, and because industry experts Gold Fields Mineral Servicesreleased their annual survey for 2008 with an accompanying bullish view.
GFMS wasnot at all surprised the gold price saw a correction recently from itshigh of US$1030/oz to below US$900/oz given the speed of the prior runup. Nevertheless, chairman Philip Klapwijk believes the fundamentalsbehind that bout of bullishness are "still very much with us",particularly US dollar weakness and "skeletons in banks' closets".
Klapwijkthus suggests gold could potentially make it to US$1100/oz this year,although he believes US$1200/oz would be "going a bit far".
Thereason is that in the cold hard light of day, gold plays a dual role.Its dominant role in the financial markets is one of a currency - analternative to the US dollar reserve currency in particular and allpaper money in general. It is a hedge against dollar weaknessspecifically, and against economic weakness, inflation, and financialand geopolitical turmoil. It is traditionally the safest of safehavens, but it pays no dividend.
However,75-80% of the world's gold production is acquired not by investors orcentral banks, but by jewellery manufacturers. Unless there is a strongdemand for jewellery, there cannot be a sustained demand for gold. Asthe gold price has run up from its lows to its highs in the pastdecade, the meaningful pullbacks have often occurred as jewellerydemand has fallen - fallen because the price is just too high.
The bulkof demand comes out of Asia, particularly from traditional sources suchas the Indian "wedding seasons" and Chinese gift occasions. Whileoil-rich sheiks in the Middle East and wealthy American industrialistsmight be typical buyers of gold jewellery, it is the poor sap middleclass Indians and Chinese who are forced to buy gold lest they loseface in their communities. When the price gets just too high, the giftsget smaller, and gold demand for jewellery wavers.
In recentyears the growth of commodities funds and investment products has seena much greater demand from investors, helping to drive the price ofgold. In the meantime, the economies of China, India and otherdeveloping countries have boomed, providing higher incomes to those whoneed to stump up with the trinkets. Thus the cut-off level for goldjewellery demand has risen higher each year, providing a graduallyincreasing support level on pullbacks. Gold has thus followed a patternof running ahead of the jewellery demand threshold, blowing off andfalling back, and re-establishing jewellery demand at the new level.
This iswhy Klapwijk sees $1100 as a possibility in 2008 but not $1200. Thelatter price is a bridge too far for jewellery demand just yet.
But it isalso why 2007 saw gold begin the year at just over $600, and then spenda good six months stuffing around at the $700 mark. There was an awfullot of derivative market selling going on at $700 (we won't go into why- GFMS is a not a supporter of manipulation conspiracy theories). Ittook the collapsing US dollar at the onset of the credit crunch forgold to take off, but at below $700 there was a sustained demand forjewellery. It was a classic Mexican stand-off.
Now thatwe have since hit $1000, it is interesting to note the "physical"drivers behind the gold price rise in 2007, other than the "wealthpreservation" effect.
Actualmine production, which has been on a trend decline for decades, fell by0.4% in 2007 to an eleven-year low. The biggest falls were in SouthAfrica, where mines have been forced into rolling closures due to powersupply problems, but both North and Latin America also experienceddeclines. The winners were Indonesia and China. In 2007 China becamethe world's premier producer of gold. There was little assistance fromthe "scrap" market, where sales fell 15%. Klapwijk puts this down tothe sellers holding out for higher prices.
On theflipside, "official" (central bank) sales increased in 2007 over 2006,which was almost entirely due to selling among the European CentralBank Gold Agreement countries. Under the agreement member countries canonly sell 500t per year (Sep-Sep) in total, and while 2006 saw centralbanks mostly preferring to keep their gold, 2007 saw big forced salesfrom a troubled Spain and an orderly selling program from the Swiss aspart of a portfolio adjustment exercise. Outside of the CBGA (where agreat proportion of the world's gold is held) other central banksbecame net buyers for the first time in over a decade.
Jewellerydemand in 2007 grew by 22% in the first half, providing that support at$700. As the gold price took off on credit crunch fears, jewellerydemand fell 9% in the second half. That helps to explain why a big holeopened up in the market just recently - there was no physical supportat such high prices.
A threatto Klapwijk's US$1100 forecast may have come from the announcement thisweek the International Monetary Fund intends to sell 403t (13moz) ofits 3217t holdings. When the announcement was made the gold price tooka bit of a dive in an already fragile market.
However, all veteran gold traders know it is foolish to fear the IMF.
The IMFhas been threatening to sell gold since about the time Columbusreturned from the New World. If you earned a dollar every time the IMFgleefully announced it wanted to sell gold, you wouldn't need to investin gold. Veteran gold traders always greet such proclamations with ayawn. Usually nothing happens and the IMF shuts up for a while.However, this time it might just be a bit more serious, given the Fundneeds to consolidate and restructure itself from an over-bureaucratisedleviathan with limited investment power into a sleeker model with theopportunity to bring its investment charter into this century.
In orderto sell gold, the IMF must gain approval from 185 member countries and,more importantly, the US Congress. The last time the IMF actuallywanted to sell gold was in 1999, and Congress knocked it on the headand told the IMF to go away and start thinking about reducing its owncosts. Whenever the issue has been raised since it has taken only aslight rise of the eyebrow from Congress and the IMF has crawled backtimidly into its box.
But thistime it appears IMF MD Dominique-Strauss Kahn has a rationalisationplan that may just meet with Congressional approval. If that's thecase, then the IMF will be free to start dumping great loads of gold.
But don'tdespair. The Fund's intention is to simply ease out bullion over anumber of years in such a way as to not upset the prevailing market.The implication here is it will not sell into a falling market, ortrigger a market fall, but rather ease gold quietly into a risingmarket. Moreover, it will incorporate itself into the CBGA framework,such that any IMF sales will only occur if the CBGA quota (500tpy) isnot reached and it won't allow that quota to be breached. Any saleswill also be fully transparent.
In thisway any IMF selling would be no different from European central bankselling, and bear in mind that European banks sold 480t in 2007 (30% upfrom 2006), yet gold rose from under $600 to over $700 in theSeptember-September period. The CBGA banks have sold a further 191talready since September 2007 and gold is now over $900.
Bewareirrational exuberance, says Klapwijk. GFMS is long term bullish, butthese sudden bursts of energy only create a vacuum of diminishedjewellery demand in the short term.
Investorsthus should either buy gold and put it in the bottom drawer, and onlycheck the gold price yearly, or sell on parabolic rallies beforere-establishing at US$100-150 lower. Sounds easy, doesn't it?