DEZ
Gold Gains Look Precarious
Oxford Analytica, 02.20.06, 6:00 AM ET
Provided by Oxford Analytica
NEW YORK - The rapid rise in the price of gold since September defies traditional explanations of the metal's value. Whether its rise is temporary or permanent will have profound implications for investment in new production, as well as providing clues to investor sentiment toward the global economy.
The price of gold ended 2005 at $513 per ounce, a year-on-year rise of 18%. Last month, it increased by a further $50. Gold prices have been rising since 1999, when they hit a low of $252.70 per ounce. Changes in fundamentals account for most of this recovery:
--Supply has been limited by the dearth of exploration in the late 1990s, itself a consequence of the collapsing price.
--Central bank sales, having dogged the market in the 1990s, have been fairly constricted since the onset of the European Gold Agreement of September 1999.
--On the demand side, strong economic growth in key consumers, such as India, have helped jewelery sales, along with a shift in fashion trends to yellow-metal jewelery in Western countries.
Yet, explanations of this kind cannot account for a rise at the speed seen in the third quarter of 2005.
In recent years, most analysts would have had a straightforward explanation for any jump in the gold price--a collapse in the dollar.
The negative correlation between the dollar and the dollar-denominated gold price was strong between 2002 and the first half of 2005.
However, in the second half of the year, as the dollar continued to make gains against most other currencies, the gold price in dollars also rose. Therefore, the gold price gains in other currencies were even larger than those in dollars. In euros and yen, gold last year gained 36% year-on-year.
Factors internal to the gold market, especially investment demand, account for the strong price performance. Compared with the size of equity or bond markets, the gold market is small. Gold enthusiasts, wedded to the idea of gold as an asset as much as a commodity, have long been convinced that there is a large potential investor community waiting for the right moment to invest. Last year went some way toward reassuring them that they were right.
The most active investment has come from a mix of private investors:
--Exchange-Traded Funds: The most visible signs of new investment in gold have been relatively new gold-backed ETFs. Total investment in these funds in 2005 was about 5% of global demand: larger than the reserves of some central banks. However, the speculative nature of these investments suggests that investor interest may only be short-term.
--COMEX/TOCOM: The other, more traditional, form of gold investment (or speculation) is on the futures markets: New York's COMEX and Tokyo's TOCOM. The "long" position on COMEX (traditionally calculated as the net positions of the non-commercial speculators) rose from 565 tonnes at the end of 2004 to a peak of 708 tonnes in October. Investors on TOCOM then took over, with the General Public (i.e. non-professional/industrial investors) position, which had begun the year at 85 tonnes, rising to 258 tonnes in December. This was by far the highest figure ever, and coincided with the rapid price gains. As with ETFs, speculation appears to have been a powerful motivator for investment.
While private investment has exceeded expectations, the same cannot be said for official investment demand:
--Europe: Under the terms of the 1999 and 2004 European Gold Agreements (EGA I and EGA II), gold sales were limited to 400 tonnes a year for five years, raised to 500 tonnes a year in EGA II. Many market participants hoped that sales during this second round of the EGA (extending to 2009) would not reach this higher limit.
However, early indications are that EGA II "limits" are in fact targets.
--Worldwide: As hopes have faded that the European central banks would stop selling, those inclined to be bullish about gold's future performance have argued that countries such as China, with large foreign exchange reserves but relatively small gold holdings, would increase their gold reserves.
Russia and South Africa have also been mooted as potential buyers of gold for their official reserves. However, such hopes are unfounded.
These countries have such large forex reserves that they would need thousands of tonnes of gold to reach the "appropriate" level.
This does not mean that central banks will not buy gold again. It is widely understood within the gold market that some Middle East countries have recently bought quantities of gold, diversifying some of their petrodollar profits. However, even if true, this should not been seen as anything more than a trading position.
The sharp acceleration in the gold price since September 2005 is based on private investor interest.
The official sector has shown no signs of reversing its hostility to gold as a reserve asset. Private speculators, rather than dramatically improved supply-demand fundamentals, are driving the rally, which suggests that it is precarious.
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