Gold is currently trading at US$1 651 after peaking at US$1 923 in September 2011, a drop of 14%. Silver likewise has lost 35% from its highs of US$48,70 registered in April. Platinum is at present trading at US$1 570, a price lower than that of gold whilst the nickel price at US$17 945 equates to a decline of 38% from the 2011 peak of US$29 050. What initially looked like the best home for investments is now a hot spot — if you do not get it right you will be burnt severely. Sentiment on gold in particular now seems bearish. What could have caused this blood bath and is the storm over?
Chief amongst the reasons for depressed gold prices is the fact that its demand as a hedging asset has declined as investors have reverted to the US dollar as a safe haven. Demand for gold firmed in 2008 when the US economy was tangled with the sub-prime mortgage crisis. In times of chaos and uncertainty investors traditionally opt for gold.
However, lately, the US economy appears to have turned the corner and this has seen investors preferring the dollar again to gold as a hedging asset. The dollar is strengthening on the back of positive economic reports from the US economy evidenced by unemployment levels improving to 8,2% in March 2012 from 9% in September 2011. Better company earnings together with some green shoots from the housing market have also cemented demand for the dollar. Positive outlook on US companies has also seen some investors switching into equities evidenced by the strong performance by US bourses in the first quarter. The Dow Jones put on 7% and the S&P 500 surged 12%.
Demand for physical gold also suffered from the hike in margins by the CME Group as this pushed away small speculators. The decision by the government of India to double duty on gold imports from 2% to 4% to manage the country’s current account deficit also contributed to the decline in physical demand for gold. India commands the largest demand for gold accounting for 23% of the world gold sales of 4 067 tonnes. Gold Exchange Traded Funds across the globe have also been reducing their holdings on the back of the subdued outlook.
The US dollar again is benefitting from the weakness of the Euro. Though Greece over the period managed to secure a bail-out loan of 130 billion Euros from the European Union and International Monetary Fund (IMF) which temporarily eased the region’s debt worries, evidence on the ground seems to suggest that a lot of challenges remain unresolved. The web appears to be spreading over the whole continent. Of late, yields on Spanish and Italian bonds have firmed, which is an indication that lenders are demanding a premium on any loans advanced to these countries.
Industrial linked commodities on the other hand are suffering from slumping growth in the Asian economies. Platinum and nickel are mainly used in industrial processes with 40% of production of the former absorbed by the car industry. Latest statistics indicate that the Chinese economy grew by 8,1% in the first quarter of 2012, down from 8,9% achieved in the fourth quarter of 2012. This is the slowest growth the economy has registered in two years and this is a result of reduced exports as demand from the European Union remains low.
The outlook might appear not so bullish for those holding commodities, particularly precious metals. Gold is likely to remain weak, largely due to the positive correlation it has now developed with the Euro. The regional currency is expected to remain weak as countries like Spain and Italy still face difficulties. The European Central Bank might be forced to inject more cheap funds onto the market and this will give rise to fears of inflation and weigh negatively on the Euro.
Prospects of industrial linked commodities like copper, platinum and nickel to a greater extent rely on the fortunes of the Chinese economy which in turn hang on the improvement in product demand in the global economy. As things stand, the game changer looks likely to be the decision the Federal Reserve will take with regards to quantitative easing three (QE3). If the FED goes ahead with QE 3, then gold prices are likely to surge as injection of more money in the economy is likely to induce inflationary pressures.
We nonetheless see the dip in gold prices as a possible buying opportunity for investors able to take a long term view. Short term gold prices are likely to remain volatile. Continued loose monetary policies by their central banks have resulted in inflationary pressures in many countries.
Though inflation does not appear to be a pressing concern in the US currently, the situation might change if oil prices continue to rise. Rising oil prices will hurt economic recovery as they affect business and consumer spending. This might prompt the FED to go ahead with QE 3. Furthermore, the global financial system still remains fragile and the sovereign debt problems in the Euro zone are far from resolved. Any escalation of the European debt crisis or political risks resulting from the tensions in the Middle East could push gold higher.
Also worth noting is the fact that gold prices and demand have been going up in the past decade at a time global mine production has not increased much and likely to stay more or less stagnant in the coming years.