Gold hit a new (nominal) record high on the London fix in dollars on 11 May at $1,222.50/oz. This surpassed December’s peak and means gold has risen in price by 8% since 22 April this year, a period in which other metals have performed poorly; platinum for example was down 2%, palladium down 7% and even certain base metals were down 10%.

This was achieved despite an increase in the dollar over the same period, rising 4% on its index and 5% against a sickly euro. This meant gold in euro terms, and many other currencies such as sterling, set further new all-time highs, rising to levels considerably higher than the price peak of December 2009. Since 22 April gold has risen 13% when measured in euros, and is now a remarkable 44% higher year-on-year (in dollars it is 34% higher).

The euro in fact is a key reason why gold is higher. The eurozone’s economic problems first boosted gold as investors feared a rolling collapse of government debt markets, starting with Greece and spreading to countries such as Portugal and Spain, threatening the cohesion of the eurozone itself. As fears hit equity markets worldwide the gold price surged higher, with no repeat of the short-term sell-off it has seen in previous financial panics.

Gold then also gained after the eurozone rescue package was announced over the weekend of 8/9 May. But this gave only brief respite as on reflection markets took the view that this implied a weakening of the European Central Bank’s independence and loosening of its antiinflationary zeal. We think this is important, as the ECB was perhaps the last central bank holding firm on maintaining a strong currency, and its capitulation (if that is what it was) has boosted gold’s attraction as a currency that cannot be printed.

What evidence is there of an investor boom? The exchange-traded funds have been seeing consistent inflows. Those in the week to 7 May, at 1.145 Moz, were the highest in a weekly period since March 2009. Although the levels are not yet up to those seen during that earlier period, the week to 7 May this year was the 12th week in a row in which there had been net inflows, making a cumulative increase of 3.5 Moz, over 100t. The US Mint also reported strong coin sales, with 41,500 oz of one-ounce Eagles sold in the first week of May, not far off the 60,500 oz sold in all of April.

The other important news is that the International Monetary Fund (IMF) is selling gold, and apparently rapidly. The Fund sold 18.5t of gold in March, much more than the 5.6t it sold in February, which was the first of its on-market sales. If this pace is maintained in future months then the IMF would complete its planned sale of 191.3t by the end of the year (1 month of 5.6t and 10 months of 18.5t = 191t).

However the IMF is the gold only seller around; sales from the Central Bank Gold Agreement (CBGA) signatories have been just 1.3t since the start of the new Agreement in late September 2009, and essentially zero in 2010. We know of no planned sales for the rest of the year. If one includes in this total our forecast IMF sales (the IMF is not a signatory to the CBGA but the signatories agreed its sales would be accommodated within their 500t/year limit) up to the end of September (the end of CBGA year), then first year CBGA sales will be less than 120t.

Short term outlook on Gold

Gold made further gains on 12 May, climbing to $1,240/oz in intra-day trading. Where next? How much higher can gold go? What trend guides can we resort to? Those with long memories will perhaps look to the all-time high in real terms, which was the $850/oz fix of 21 January 1980. Adjusted for US prices, $850/oz is, in nominal terms, much higher than today’s price; inflated by the PPI, it would be $1,836/oz; inflated by the CPI it would be a remarkable $2,389/oz. Of course it could be argued that it is rather misleading to focus on the 1980 high.

That really was an unsustainable ‘spike’; gold was there for just a single day and above $800/oz only for one other day, which happened to be the day before that. The average dollar gold price for January 1980 was a rather lower $675.10/oz, which in today’s money is equivalent to $1,458/oz (on the PPI) or $1,897/oz if one uses the CPI. These perhaps represent more realistic “targets”.

But how realistic are they really? One issue must be in what state Jewellery demand will be if the gold price does go that high. Of course it won’t be Jewellery but rather investment demand that would push it that high. Yet one can’t help but feel uneasy when the price of a commodity is so divorced from its traditional major consumption source. Another issue is what it would mean for the global stock of gold, estimated at about 5.5bn ounces, worth over $6 trillion at current prices.

Will high gold prices see a dampening effect from huge scrap sales? And how will central banks respond – the euro zone collective has 347 Moz of gold, so every $100 on the price adds $35bn to its assets. For a continent struggling with government debt this must seem very tempting indeed. On the other hand, the Bundesbank must be silently groaning at the rescue package for profligate Greece – it won’t be interested in supporting the sale of any German gold to ease sovereign debt crises, no matter what the price is.

Short-term we are probably heading for some consolidation, but there is nothing on the horizon to suggest prices must fall. Short-term London fix: $1,200/oz-$1,300/oz.

Courtesy: VM Group research for Fortis Bank Nederland - Metals Monthly May 2010 - Fortis/VM Group

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