Gold overcame distinctly bearish physical supply and demand trends to find its way higher once again last year as investment demand continued to prop up prices. Indeed, according to figures compiled by GFMS Limited – a leading precious metals consultancy – mine production hit a record high in 2011. Meanwhile, jewelry demand, the most important source of physical gold-buying, suffered losses even in typically strong markets like China and India. By contrast, global investment demand rose over 20 percent to a record $80 billion.
Why Do Investors Like Gold?
Investors seek out the yellow metal for its store-of-value properties. This makes it attractive in two diametrically opposite scenarios. At one extreme, there is fear of inflation. Some people believe that the global economic recovery will gain significant momentum before central banks are able to rein in ultra-loose monetary policies and buy gold to hedge against the debasement of paper currencies. At the other extreme, some fear that the current weak recovery will come apart as stimulus efforts run dry. They like gold as an asset that will retain its intrinsic physical value even if financial markets break down anew.
Looking ahead, this makes for a deeply conflicted outlook for gold prices amid lingering uncertainty about the global macroeconomic environment in the year ahead. The headwinds facing the global recovery remain formidable, with the Eurozone debt crisis still a concern and boiling tension between Iran and Western powers threatening to disrupt oil supply chains, which could send crude prices soaring. On the other hand, the US economy seems to have gained some traction in the second half of 2011 and may help offset malaise elsewhere.
Is the Eurozone Debt Crisis Good or Bad for Gold Prices?
Turning first to Europe, the implications of lingering solvency fears in the Euro area for gold prices depend on the degree of sovereign stress. Over the past three years, EU policymakers managed to do just enough to avoid an outright default in a Eurozone member state but failed to meaningfully put to bed concerns that this may still happen in the near-term. Understandably enough, this has weighed on business and consumer confidence as well as hurt economic growth. This compounds the impact of austerity measures meant to trim runaway budget deficits. It has also produced a series of flare-ups in market-wide risk aversion as traders have been were routinely reminded of the problem by ratings agencies, spiking bond yields and a seemingly endless series of lackluster EU summits aimed at fixing the crisis.
If this status quo is to continue as policymakers limp toward a deeper fiscal union that ultimately lays the foundation for a restoration of budgetary discipline, the debt crisis’s impact on gold prices is likely to prove negative. Bouts of risk aversion stoke demand for liquid safe havens. This notably benefits the US Dollar, both via demand for the currency itself and for US Treasury bonds. The result is de-facto downward pressure on gold since the metal is denominated in terms of the greenback. Meanwhile, a now widely expected recession in the Eurozone – the world’s largest economy when taken collectively – is likely to keep prices in check, negating demand for a hedge against inflation.
If a disorderly default does materialize however, a credit crunch greater than that witnessed in 2008 promises to send paper assets into freefall once again, offering support to gold prices.
The US Recovery is Gaining Momentum – What Does This Mean for Gold?
Turning to the US, it appears that a fragile economic recovery is gaining ground. The tone of economic data began to noticeably improve in the third and fourth quarters of 2011 and economists’ consensus forecasts now suggest GDP will grow 2.3 percent in 2012. This would be a marked acceleration from the 1.7 percent increase recorded in 2011. At the same time, the Federal Reserve has lurched further toward the dovish side of the monetary policy spectrum, extending its pledge to keep interest rates “exceptionally low” by a further 18 months to the end of 2014.
Taken together, it is not surprising that these two developments have produced a strong pickup in inflation expectations (these are tracked by “breakeven rates”, which are the difference between yields on nominal and inflation-adjusted US Treasury bonds) and driven gold higher. The critical question going forward is whether the Fed is right in its apprehension about the growth outlook, and to what extent.
If the pickup noted in the second half of 2011 continues to accelerate while the Fed clings to an accommodative monetary policy posture, investors’ outlook for price growth will continue to strengthen, boosting gold prices further. Likewise, if the recovery begins to fall apart anew and prompts Ben Bernanke and company to introduce a third round of quantitative easing (QE3), gold has scope to climb as traders look to the metal for refuge against the Fed’s debauching of paper currency. In the case that the recovery slows only mildly such that inflation bets are contained but QE3 is not deemed to be warranted, gold will find it hard to continue higher.
Gold Outlook Cautiously Bearish in the First Half of 2012
While much remains uncertain and many of the components shaping the outlook for gold in the first half of 2012 remain in flux, we see the path of least resistance as likely favoring the downside. On the European front, the role of the ECB is proving critical. The bank is acting aggressively to secure Eurozone member states’ ability to borrow by buying sovereign debt. It is also flooding banks with cheap cash through 3-year LTRO operations counteract a credit crunch if a default does happen.
On balance, this means that an Armageddon-level scenario is unlikely at least over the medium term. While flare-ups in risk aversion are likely to continue as solvency worries reappear from time to time, this is likely to be the kind of stress that boosts the Dollar and Treasuries rather than unleash another market-wide meltdown. This bodes ill for gold.
As for the US, the recovery seems clearly stronger but remains fragile and uneven, which appears likely to keep inflation pressures at bay while discouraging the Fed from adopting QE3. Indeed, it seems Ben Bernanke and company have a much higher threshold for another round of asset purchases than previously, opting to conspicuously shift their approach towards a communications- and transparency-based strategy. This is likely to erode demand for gold as a hedge against runaway price growth.
-- Ilya Spivak, Currency Strategist, DailyFX
Gold is off to a thunderous start in 2012, advancing nearly 11% in January. January’s rally is the largest monthly advance since August. August turned out to be exhaustive, with gold plunging in September. The difference, of course, is that January’s rally follows a decline of over $300, which raises the possibility that the recent rally is the beginning of the next leg up in the decade-plus long bull market. By the same token, the 4-month decline from the high is the second largest in percentage terms since the decline into the October 2008 low. The decline into October 2008 was exhaustive on the downside but gold didn’t make much upside progress over the next year. These recent extreme rate-of-change figures are consistent with a peak in volatility for at least several months. In other words, expect gold to drift sideways between the 1900 area and the recent congestion centered around 1650. A range trading strategy is best employed with strict adherence to the mentioned levels. A drop below the December low would trigger a regime shift and more than likely a panic decline towards the 2011 low and 1300.
-- Jamie Saettele, CMT, Sr. Technical Currency Strategist, DailyFX