Gold Price Path to $3,000 Cemented on Dubai Default?
November 30th, 2009 - 9:46 am | by GoldAlert
My note
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David Rosenberg (he is NOT a gold bug) is one of
the smartest people on the planet.
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However, Rosenberg went on to write, “Don’t mistake this for a bearish call … we still see gold approaching $3,000/oz. before the secular bull market runs its course.”
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The gold price steadied near the $1,170 level while investors weighed whether the price of gold, gold mining stocks, and other assets such as emerging market equities and cyclical commodities were set to correct further following the surprise announcement out of Dubai last Wednesday.
News that heavily-indebted Dubai World, a state-owned entity of Dubai, announced a six-month standstill on its debt obligations sent shockwaves through the global marketplace. In concert with declines across global equity markets, the gold price dropped violently on the news, swooning roughly 5%, or $52, to a low of $1,138 per ounce after hitting a high of $1,195 just a day before.
Risk aversion returned, best exemplified by the spike in prices for credit default insurance for sovereign nations across the globe.
Over the weekend, the central bank of the United Arab Emirates sought to calm the marketplace by announcing that it will stand behind its country’s banks that are exposed to potential losses stemming from state-owned Dubai World’s possible debt default. Dubai, the most aggressive of the seven emirates during the global construction boom, was in many ways a symbol of the emergence of frontier markets.
The BRIC countries - Brazil, Russia, India, and China - received the bulk of the attention, but Dubai came to be viewed as not only the tourist and financial epicenter of the Middle East, but also the model for many emerging nations looking to emulate the Western lifestyle.
Dubai’s debt default is a wake-up call to many investors that the emerging markets, while offering superior growth prospects, carry significantly greater risks.
Risk is the operative word emanating from the situation in Dubai as the idea that the credit crisis has passed is now being reexamined. The question now is where is the next Dubai? Today’s cover of the Financial Times reads, “Is Greece Next?”
Over the past eight months, risk appetites have increased as confidence has grown that the worst of the global recession is in the past.
Only with the benefit of hindsight will it be known whether the Dubai default represents the second leg of the credit crisis - but the mere fact that this theory is even being espoused represents a potential headwind to the markets.
News that the central bank of the United Arab Emirates will aid its city-state has helped to calm markets.
However, severe damage has already been inflicted to Dubai’s standing in the global marketplace - and by extension to all frontier markets. Uncertainty breeds volatility and the fact that Dubai called for a six-month “standstill” without providing much detail was one of the chief reasons for the initial violent market reaction.
Speculation is swirling as to whether the Dubai debt default is a catalyst for a counter-trend rally in the U.S. dollar and/or a reversal of the vigorous 8-month uptrend in nearly all asset classes.
While the gold price has appreciated 38% off its April low print, the oil price has moved 69.5% off its 2009 low. The S&P 500 rallied 67% from its March low to last week’s high and China’s Shanghai and India’s Sensex have moved 83.8% and 114% off their 2009 troughs.
The point is that regardless of the solid fundamentals underpinning the gold price, the tailwind from an expansion of risk appetite has benefitted the gold sector.
If risk aversion and a new round of deleveraging emerge, then the increasingly popular dollar carry trade will be unwound - and the gold price and gold mining stocks would be at risk of a deeper correction.
Of further worry to gold bulls is the elevated sentiment readings in the gold market and the vast array of front page headlines covering gold’s ascent near $1,200 per ounce.
While retail enthusiasm towards gold mining stocks appears to be relatively muted, there has been a rush for gold coins. The U.S. mint announced last week that it suspended sales of the world’s most popular gold coin, the American Eagle. There has been a roughly 75% increase in sales of American Eagles versus the previous year.
David Rosenberg, chief market strategist at Gluskin Sheff, commented that “like many other risk assets, bullion is a crowded trade for now.”
However, Rosenberg went on to write, “Don’t mistake this for a bearish call … we still see gold approaching $3,000/oz. before the secular bull market runs its course.”
While the news out of Dubai has the potential to cause a correction in the gold price and gold mining stocks due to general liquidation of all assets, over the longer-term the news out of Dubai looks set to add fuel to gold’s secular bull market rise. The Federal Reserve, as well as its counterpart central banks across the globe, will become even more concerned about the stability of the financial system. This heightened concern will lead to a greater reluctance to normalize monetary policies and will perpetuate deflation-fighting initiatives. Money supply growth is likely to continue its upward trajectory and, as a result, degrade fiat currencies. Every soft economic data point or threat to the flow of liquidity through the markets strengthens the resolve of central bankers to continue their maintenance of an unprecedented array of monetary policy initiatives - highlighted by quantitative easing.
In the meantime, the balance sheet of America continues to deteriorate with the Obama administration projecting a rise in the national debt to $17 trillion (currently $7 trillion) over the next decade - an outcome based on optimistic GDP growth assumptions and one that omits the trillions of unfunded liabilities due to Social Security and Medicare. A macro-economic climate characterized by a weakening U.S. financial position and widespread global accommodative monetary and fiscal policies is the ideal backdrop for the gold price and gold mining stocks. Notwithstanding corrections along the way, the gold price looks set to move considerably higher in coming years as the Dubai debt default further ingrains in the psyche of central bankers fears of revisiting the 1930s Depression era.
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