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9 Mar 2012

Currency Knowledge Series 16- Outlook for Gold

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Gold is losing its flight to safety value and at levels of USD 1700/oz is trading near its all time peak of USD 1895/oz. The USD outlook is not highly negative

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Arjun Parthasarathy

Gold is losing its flight to safety value and at levels of USD 1700/oz is trading near its all time peak of USD 1895/oz. The USD outlook is not highly negative  for gold to move up on USD weakness. Unless there is a surge in demand for gold by central banks or by retail buyers, gold as an asset class will underperform equities in 2012. The coming back of risk appetite will drive equities as worries of 2011 ebb away.

Gold will languish in 2012

The two month price movements of equities, gold, silver and the US Dollar (USD) are indicating fundamental shifts in market trends.

Silver has outperformed gold and equities, while equities have outperformed gold. The USD has hardly moved. Will this trend continue with silver becoming the best performing metal while gold languishes in the face of equity rally that is driven less be USD weakness and more by Yen and Euro carry trades?

Gold had a good 2011 with over 11% returns. Gold prices touched peaks of USD 1895/oz during calendar year 2011 as markets worried over inflation in emerging markets such as Brazil, China and India and worried about the effect of sovereign debt issues of the US and Eurozone countries on their currencies. Inflation in emerging countries were at three year highs in the face of rising food prices coupled with stimulus driven economic growth post the 2008 credit crisis. The US faced a rating downgrade as it sought to increase its debt limit, while the Eurozone nations faced a lack of demand for their debt on the back of Greece becoming bankrupt.  The fate of the Euro itself was being questioned on the back of the debt issues.

The issues that took up gold prices in 2011 are slowly weakening in intensity. Inflation in emerging markets is looking down, with China’s February 2012 inflation at 3.2% against peaks of 6.5% seen in 2011. India’s inflation for January 2012 was at 6.55% against double digit inflation seen in 2011. Brazil started cutting interest rates in August 2011 on the back of growth worries rather than inflation worries. Weakening growth outlook in emerging markets is bringing down inflation expectations. China’s GDP growth target for 2012 is 7.5%, which if it comes as per forecast will be the lowest since 1999. India has revised its GDP growth rate forecast from 9% to 7.5% for the fiscal 2011-12, and its third quarter 2011-12 GDP at 6.1% was at a two and half year low.

The debt issues of the US and Eurozone are not as frightening as it was made out to be. Yes, debt issues still exist with the US government debt running at close to 75% of GDP while Eurozone countries such as Italy have debt running at 120% of GDP. However, the level of US debt has not hurt bond yields in the US, which are down around 150 bps from end 2010 levels. The USD has gained in strength by over 1% in calendar year 2011 on worries over the Euro. Markets are not calling an end to the USD on the back of its debt.

The Eurozone debt crisis, which took a turn for the worse when bond yields of Italy, which is the third largest Eurozone nation, surged to over 7% levels, is looking at signs of stability. Italy’s debt at USD 2.2 trillion makes it un bailable and its bond yields at over 7% makes the debt unsustainable. The lending of over Euro one trillion of funds to European banks by the ECB (European Central Bank) helped bring down bond yields of Italy as well as other Eurozone nations. The ECB fund lending called LTRO (Long Term Refinancing Operation) has taken away fear from the markets.

Greece, which has technically defaulted on its debt, has successfully completed a debt swap, which has brought down its debt to private creditors by almost 50%. The country has received a Euro 130 billion of bailout funds from the EU (European Union) and this will help calm markets that were worried on Greece going out of the Euro.

 

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