After crashing $100/oz from its peak of $1,212.50/oz on 2 December to a low of $1,105/oz on the PM fix of 18 December, the Gold price began 2010 brightly. Gaining steadily, it fixed at $1,153/oz on 11 January before succumbing to a stronger dollar and heading back towards $1,100/oz.

Gold was essentially tracking the US dollar. By the time it bottomed out gold had fallen 8.9% from its peak, but this correlated with a much stronger dollar, on rising US economic optimism. Against the euro the US currency rose from 1.494 on 3 December to 1.417 by 18 December, a move of 4.7%, while on its wider index it gained 4.2%, to 77.82 from 76.31. This was the highest it had been since early September. Similarly, as gold gained in January the dollar was falling, slipping back to 1.451 against the euro and 76.7 on its index by 14 January.

Indian imports of gold picked up in December and were 34t, compared to just 3t in December 2009, according to the Bombay Bullion Association. However the association said that full year 2009 imports were just 343t, compared to 420t in 2008.

As yet no other central banks have followed India, Mauritius and Sri Lanka in buying IMF gold; because of this we expect the IMF will announce on-market sales (linked to the Central Bank Gold Agreement) in Q1 of this year.

However, Russia continues to add to its reserves, rising to 20.5 Moz in December from 19.73 Moz, equivalent to 23.9t. It is possible that this is the gold the Russian State Depository in November said it wished to sell, and which the Russian central bank said it was interested in purchasing. Elsewhere, sales of gold from central banks remain miniscule – the CBGA signatories, whose 400t/year sales limit is equivalent to about 33t/month, have sold at most 1.5t so far, in more than three months of the third CBGA.

Growth in ETF demand has been conspicuous by its absence. The market-leading SPDR ETF in the US ended 2009 with 1,134t of gold, only slightly below its all-time high, of 1,134t. However, by 20 January its holdings had slipped back to 1,111t.

Short term outlook

The market is showing some signs of nerves on the back of a stronger dollar. Will investors decide now is a good time to take profits? Short-term price: $1,050/oz-$1,150/oz.

The impact of a stronger dollar

Periodic dollar rallies are a salient reminder of two things regarding currency markets: exchange rates are a ratio of one currency to another – the strength of a currency is not just related to its own fundamentals, but that of the currency in which you are measuring it; and most studies have shown they are largely unpredictable, except perhaps in the very long run. Thus we might get a US dollar revival simply because economic conditions in other countries look worse, such as parts of the Euro zone. But there are reasons why the US currency might prosper anyway, such as if the US economy stages a stronger rebound than other economies and there is a hint that US interest rates may rise earlier than the market expects. This is not yet our view; history suggests that US interest rates do not rise until long after a recession has ended.

However, if the dollar strengthens in Q1 2010 or beyond, what might happen to Gold prices? As the table (below) shows, there have been three distinct dollar bull periods since 1980: from September 1980 to January 1985; June 1995 to January 2002; and – a much shorter run – from July 2008 to February 2009. In those periods the dollar has gained (on its index) 56%, 40% and 21% respectively. Gold fell by 57% and 27% in the first two periods (in dollars) but managed a 2% gain in the latest period. This last figure is the odd one out, but the gain then was relatively small, and perhaps testified to gold’s ‘safe haven’ role, as the dollar’s gains in that period were due to it benefiting from similar panicked flows of money. On the other hand, during dollar bear markets the price of gold has always raised, most recently from March to November 2009, when it gained 24% on a dollar fall of 15%.

Of course to some extent this is obvious, given the gold price is set internationally. If the dollar price of gold did not decline when the dollar strengthened, the price of gold in other currencies would have to rise, and there is no obvious reason why that should be. One way to analyze this is to look at the euro price of gold for the same periods. In the three dollar-bull markets, this fell by 8%, rose by 13% and rose by 27% respectively. In the three dollar-bear periods, it fell by 14%, rose by 80%, and rose by 4%. So although the dollar price of gold might get hit by a resurgent US currency, this is not so clear cut when measured in other currencies. It is the mechanical effect of a stronger dollar that hits the dollar gold price, rather than any fundamental change in the market, such as investor liquidation.

Courtesy: Fortis Bank Nederland - The Metals Monthly January 2010

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