Commodities | Nov 24 2008
By Greg Peel
Gold reached its peak of US$1030/oz in March amidst the accelerating credit crisis and a tumbling US dollar, which at the time was being hit by aggressive Fed easing and announced Fed facilities in the wake of Bear Stearns. Importantly, it was also believed at the time the crisis was still mostly US-centric and that Europe and particularly China would not suffer the same distress.
We now know the latter to be wrong, and we know that as Europe, the UK and Japan have slipped into recession they’ve actually beaten the US to it. We also know China’s growth will likely slow to 8% or under which is as good as a recession in a previously exploding economy. The result has been a sell-down of the euro and pound, causing the US dollar index to turn around and head northward once more. Were it not for carry trade unwinding, the dollar would also be rising against the yen.
We have also now experienced the final (we hope) meltdown of the credit system in the wake of Lehman Bros these last couple of months. There has been a rush to sell out of risky assets such as emerging market positions and commodity investments and repatriate cash back to the US. That cash has either been used to cover investor redemptions or pay margins, or has found its way into safe haven investments such as short-end US Treasuries. US three-month paper is now trading a whisker over zero percent yield, meaning a negative return in real terms. Such has been the panic.
This repatriation and liquidation of risky assets has also provided a boost for the US dollar, creating a seemingly illogical rally in the US dollar when the US government is madly printing greenbacks to shore up the financial system. As the whole world is doing the same thing, and cutting interest rates to match the US, the reserve currency has come to the fore. But the rally has only served to exacerbate the collapse in commodity prices.
It has also played havoc with the gold price. Gold has seen the low 700s since hitting its peak and has returned above US$900/oz again, only to be smashed down once more. Those looking to buy gold as a safe haven have met waves of liquidation sellers coming the other way, as well as the simple mathematics of US dollar pricing. Having traded under US$700/oz once more, gold has recently traded in a consolidation pattern under US$750/oz. But on Friday, it broke to the upside.
Gold rallied over US$50 to almost US$800/oz on Friday. A slightly weaker US dollar allowed for the break out, and then the dam opened. The world has been waiting for the rally in the US dollar to reach its peak – a peak which should signify that the currency adjustments required across the globe to represent a global recession, not just a US recession, have been satisfied. There is no guarantee Friday saw that peak, but the market is jumpy nevertheless. And it is short.
Retail gold investors have been somewhat confused with gold’s performance of late, given retail demand for gold has been unprecedented. Mints across the globe have simply run out of coins and retail bars as they have not been able to keep up the supply. Yet while there has been extreme demand at the 800 level, gold has done nothing but wallow in recent weeks.
That might have begun to change.
ResourceInvestor.com reports that “the largest of the largest traders of gold and silver futures continued to report very low net short positions [last week], right near the lowest net short positions they have had in years”. At the same time, the World Gold Council reports that demand for physical gold (for coins and bars or to be fashioned into jewellery) has been “tremendous”, especially in the Middle East, India, Indonesia, Asia and Europe. Buyers of physical gold have been paying wide premiums for metal above what the benchmark Comex futures price suggests.
Clearly the gold price has been kept in check by the need for speculative liquidation and by forced selling to raise cash to satisfy margins in stocks and other investments. Gold has been a victim of the “everything must go sale”. The weight of selling has undermined the fact that there is also an incredible weight of buying underneath.
We know that the world expects – at some point – that global currency adjustments will reach a conclusion and the US dollar will start to look very vulnerable as a new Administration moves in to deal with the economic crisis. The US dollar will begin to fall. We are not sure when exactly when this might begin.
We are not sure because we can also not be sure just how much further global deleveraging has to run. While deleveraging could last right through 2009, the question is as to whether the remainder of positions to be liquidated will have the same force as the great rush of 2008, or whether the pent up pressure on the buy side of gold will explode through what is left of the selling. Was Friday a hint?
Gold was able to break out of its consolidation pattern on Friday largely as a result of the Citigroup demise reaching some sort of crux. As what was once America’s greatest banking conglomerate enters its death throes it is assumed a resolution will be reached involving some form of rationalisation, consolidation, or government-assisted rescue plan. Or all of the above. Either way, the fall of Citi is enough to encourage safe haven gold investment even if Citi will not be allowed to “fall” per se.
When the break-out level was reached, the rush was on. Clearly the professional market is well short, as ResourceInvestor suggests. We have, however, seen these US$50 rallies before, only to see excitement fade once more as the sellers move back in to win the day. We nevertheless know that while short-covering may have been a feature on Friday, there is plenty of real demand in the market to bolster a rally.
Has gold finally begun its move?
The question is even more compelling in Australian dollar terms. Australian gold investors failed to gain much out of the early 2008 rally up to US$1030/oz given the Aussie was pushing towards parity with the greenback. But while US dollar gold has been weak ever since, the fall in the Aussie to US$0.60 has meant a stable to higher Aussie gold price in the last couple of months.
Were US dollar gold to begin rallying back towards US$1000 it would require the US dollar to be weaker. However, there are few who might suggest the Aussie will thus be on its way back to parity given expected ongoing weakness in real commodity prices and the effect of the yen carry trade. The yen carry trade provided much of the impetus for the Aussie’s run up, and has provided much of the impetus for its recent collapse. It is unlikely that stability in financial markets would ever encourage a return to massive carry trading in the medium term. Those days are gone.
The end result thus should be that a rally in US dollar gold will also prompt a significant rally in Aussie dollar gold.