By Jane Louis St. LOUIS (ResourceInvestor.com) -- The U.S. Federal Reserve’s quarter-point rate cut was no surprise today. In fact, the markets had mostly already factored in the cut, with gold actually losing $1.80 to $811.10 per ounce on the news and the dollar trading at € 0.6811 and 111.11 yen.
But the cut was much more significant to the gold market than it seemed. According to Jessica Cross, chief executive of commodities consultancy the VM Group, the U.S. economic outlook is going to be the main driver of the gold market in 2008.
“Most of all…we look to the performance of the dollar and the background economic outlook for the U.S. in its presidential election year as our main guide to the price trend for gold in 2008,” Cross said in the VM Group and Fortis Bank’s “The Yellow Book”.
“The Yellow Book” is a biannual analysis and overview of the global fundamentals driving the international gold market. According to the latest edition, which was released today, Cross and the VM Group expect interest rates to be cut further in 2008 - which will be good news for gold.
“Given that it is an election year, there will be pressure from the Republican Party to give its candidate a hope of being selected for the White House, and the Federal Reserve will do whatever it takes to stave off the threat of recession,” the report said. “This will translate into much lower U.S. interest rates - perhaps a cut to as low as 3% by the end of 2008 - and a weaker dollar overall than today (against some specific currencies, including perhaps the euro, it might gain).”
The dollar and gold generally move inversely, as gold is often seen as a safe-haven investment and a hedge against inflation. If the Fed continues to cut interest rates, the dollar will keep falling against foreign currencies and the gold price is likely to rise as investor demand grows.
But rate cuts may not be enough to fend off a recession, according to the report. If the U.S. economy slows down too much, equities will drop.
“Gold could therefore benefit from this ‘double whammy’ - lower interest rates and a rush from equities. If the price does not rise to $900/oz some time in 2008 it will be a great surprise; equally, if the background macro-economic picture in the U.S. deteriorates further, and a weaker dollar prevails, and if gold fails to hit $900/oz, it will be a strong indicator that gold has reached a new historic ceiling.”
2008 Rollercoaster Ride
The next year is likely to be “one of the most volatile for many years,” according to Cross, with supply and demand levels in a delicate balance.
The VM Group expects 2008 to see a supply surplus of 123 tonnes on total supply of 3.75 million ounces and total demand of nearly 3.63 million ounces. The group notes, however, that since the surplus is so small, it could turn into a deficit if any of the major components change, including sources of supply, such as mine supply or central bank sales, and sources of demand, such as jewellery consumption, ETFs and dehedging.
Because the surplus is small, “investors need to remain faithful to bullion - which, given the background macro-economic problems relating to the probability of a U.S. recession and a still weaker U.S. currency, is more than likely,” the report said.
The collective supply deficit over the past seven years was 972 tonnes of gold, according to “The Yellow Book”, which has been a strong driver behind the current bull market.
“That overall deficit will have disappeared in 2007, for which our preliminary findings reveal a small surplus of 220 tonnes. But this substantially undershoots the 326-tonne increase in the net long position on Comex during the year. Given this large net long in investment gold, it should not surprise anyone that the $800/oz level was broken with such speed and ease.”
Despite the surplus in 2007, the VM Group found that scrap recycling levels remained surprisingly low. The firm said it expects recycling levels to stay about the same, if not lower, in 2008, despite rising gold prices.
Mine supply is also expected to remain little changed in 2008. The big news in that sector is that China will likely overtake South Africa as the world’s top producer in the next year.
“South Africa not being the top producer would once have been an event of huge magnitude, but it is now widely expected and inevitable,” according to the report. “Expansion and new projects scheduled for the medium term do not fall into the time horizon covered by this report. Even so, we have been arguing that the market is unlikely to see a massive surge in new mine supply, despite the price levels of the last five years.”
Cross and the VM Group expect central bank sales to come in below the 500-tonne limit during the European Gold Agreement year, which runs through September 2008. Total consumption by global central banks is expected to be small compared to sell-offs, especially since the group maintains that China will not add to its gold reserves.
“The amounts that would need to be purchased to make a difference would be so large as to make China a holder of gold on the European scale, and the Chinese will be aware that the Europeans have needed a sales limit in order to exit the market in an orderly fashion,” the report said.
Dehedging in the current bull market has almost completely offset central bank sales, according to the VM Group. The market is on course for net total dehedging of 400 tonnes.
“In 2008 this rate will surely slow, we estimate to 210 tonnes, as the bulk of the major dehedging has now been done,” the report said. “Yet the risks are on the side of higher dehedging - the success so far of what in effect is a gamble on higher prices will not have been lost on companies and their shareholders - and there are few signs of major new hedge programmes coming to the fore.”
Exchange-traded funds will continue to support demand in 2008, according to Cross. The VM Group anticipates that offtake will continue to hover around 200 tonnes per year.
“Cumulatively we forecast that in 2008 the total amount of gold held in the various ETFs will exceed 1,000 tonnes; this estimate could be too low if new products are launched in the Middle East and Asia,” said “The Yellow Book”.
But the group noted that funds in foreign markets may not have as much success as the U.S. ETFs because much of the demand for the funds comes from banks and investment firms.
But the real story remains in what is to come for the U.S. economy. As the Fed battles a recession and the presidential election nears, don’t expect a drop in volatility.
“By Q1 2009, with a new president in the White House, the going is likely to get much trickier for precious metals.”
By Arrangement with www.resourceinvestor.com
