Commodities | Oct 13 2010
By Greg Peel
As the following chart exhibits, gold in US dollar terms has been going one way and one way only since mid-July, in a straight line:
As the next chart exhibits, it's not hard to see why:
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This chart of the US dollar index (the greenback measured as a basket of euro, pound, yen, Swiss franc, Canadian dollar and Swedish kroner) has not quite fallen in the same straight line, but the trend is clear. Gold has risen 16% since the July low in US dollar terms and the dollar index has fallen 13%. That blip in the dollar index in August is not so pronounced in the gold price movement, but it is there.
Gold's price rise from April to June nevertheless belies the fact the US dollar was also rallying at the same time. The impetus here was the European crisis, and that crisis sent so many Europeans and British into gold that its price movement shook off the US dollar's rally. More recently the dollar and dollar-gold have fallen into their usual converse relationship however, because the European crisis has abated.
Having abated, global focus turned back to the US economy and a sudden deterioration in the data. It was at this point the Fed first heralded QE2, and it has been QE2 speculation driving gold ever since.
But QE2 speculation is only part of the story. If Beijing won't revalue the renminbi (which by default weakens the US dollar) then the Fed is forced to contemplate forced dollar devaluation, which in turn is pushing up the yen. China is also diversifying out of US bonds and into Japanese bonds which is further pressuring the yen to the upside. Hence the Bank of Japan has been forced to intervene. The Bank of England is caught in the mix looking at a similarly weak economy and thus possible QE2, while commodity countries such as Brazil have been forced into intervening to prevent their currencies going to the moon.
The world is in a Currency War. And when the world is in a Currency War there can only really be one beneficiary – gold, as measured in any currency.
A bit over a week go (Gartman Warns On Gold) I noted fears were building that while the fundamental story for a stronger gold price was undeniable, the fact the whole world had become long gold – from retail coin buyers to central banks – spoke dangerously of a short-term bubble. Respected gold trader Dennis Gartman offered that such alignment suggested “the inevitable correction will be violent and severe”. This was not, nevertheless, a declaration by Gartman that he had exited gold. On the contrary.
Gartman has simply not added to his gold positions which are in place based on gold's fundamental story in which QE2 and the Currency War are the main drivers. In yesterday's newsletter Gartman declared precious metals to be “preposterously overbought”. If one looks closely at the above gold chart one can see the “wobble” which has been occurring these past sessions around the US$1350-60/oz mark. There is clearly some resistance at this point, and gold has crossed back and forward across it a couple of times now.
“This is the sort of violent action,” says Gartman, “that all too many markets exhibit as they make interim…and sometimes terminal…tops”.
Yet still Gartman is long gold. He is not, however, long gold in US dollar terms. The reason being is that “gold's bull market is not predicated upon the weakness of the US dollar, but is instead predicated upon the weakness of currencies generally”. Gartman is long gold against the euro and pound.
If there were ever a chance for this latest gold run-up to sharply correct, it was provided by last weekend's meetings of the G20, World Bank and, specifically, the International Monetary Fund. Had the IMF members been able to reach any sort of truce on currency intervention, then gold may well have been looking at a US$100-200 pull-back. But, unsurprisingly, they didn't, and quite frankly are unlikely too. Thus gold is hanging in there.
But it's only hanging in there. Right now it appears to have stalled. And the fact that last night's minutes of the last FOMC meeting – in which the Fed again appeared to move closer to QE2 – saw a fall in both the US dollar index and the USD gold price suggests that at least for the time being, QE2 is priced in.
Standard Bank is currently “cautious” of gold at this level. While previous weeks have featured a world debating whether or the Fed would implement QE2, now the world is not arguing “if” but “by how much”. There has been talk of US$1 trillion, but then the market seems to have settled on US$500bn. This is backed up by analysis from Standard Bank.
Standard Bank uses the relationship between global liquidity (of which the Fed balance sheet is a large proportion) and the gold price to suggest the market is expecting the Fed balance sheet to expand by another US$500bn. Were the Fed not to announce any QE2 at it's next meeting on October 3, Standard Bank suggests a gold price of US$1260/oz would be realistic. Despite Standard Bank's caution, the analysts nevertheless suggest gold will continued to be supported through 2011 even if it were to correct in the meantime.
Correction warnings are largely based on the fact every man and his dog is now long gold. Mints around the world have run out of coins, central banks are no longer selling but buying, and ETF and futures holdings are extreme.
In the case of central banks, Russia's central bank has just announced it has swallowed up 100 tonnes of local production. China is similarly accumulating its own production. Chinese gold production fell by 11% in August from July but is still up 9% year-on-year (China is now the world's largest gold producer) but analysts do not expect much to make its way out into the market. Beijing wants to diversify away from the US dollar, and right now gold is a pretty good contra.
In the case of ETF and futures positions however, Commerzbank notes speculative positions held by money managers actually fell in the week ended October 5 by 5,700 to 218,716 contracts. Are money managers getting ready to get out? Well if they were, we should have seen gold weaker by now, yet we haven't. Commerzbank suggests speculative buying has been replaced by physical buying.
And that's the other factor in the mix – we have now entered the jewellery buying season ahead of Indian and Chinese gift-giving periods. The two Indian wedding seasons on either side of Christmas are fundamental, but even last week's Chinese National Day celebrations are a period when gifts of gold are common. Typically gold rallies from now through Christmas.
The caveat here is that middle-class Asians – those who have to make the “consumer discretionary” choice to lash out on expensive gifts – have to be able to cope with the elevated gold price. Asian GDP growth is strong but occasionally in past years buyers have baulked after a strong gold price run-up.
So can gold just keep going higher? Or are we really in need of at least a short-term correction, just to let a bit of herd mentality euphoria out of the release valve?
Well, as recently as Monday the analysts at Goldman Sachs were suggesting that not only will gold continue to rally, but it will rally “for an extended period”. Goldmans has shaken off the argument that there are too many speculative positions in the market by suggesting such holdings are still not consistent with the currently very low real interest rate (nominal rates minus inflation) environment in the US. This environment will pervade for some time, suggests Goldmans, and real rates may even move lower still should Fed QE2 eventuate.
And to that end, Goldmans is putting its money where its mouth is. The analysts have now upgraded to a three-month price target of US$1400/oz, a six-month of US$1525oz, and a twelve-month of US$1650/oz.
Not a lot of correction built in there.
Perhaps for a final word on gold's upside potential, take a look at this last graph (as provided by valued FNArena reader Wesley Legrand):
