Is confidence in gold evaporating?

Is confidence in gold evaporating? By Ross Norman 30 Apr 2008 at 11:27 AM

LONDON (FastMarkets Ltd) -- Journalists usually clamour to be the first to capture the headline which picks a turn in a market such as "gold bull run over" - analysts can find themselves met with loaded questions for some sort of affirmation that this is so - and with gold still in a six year bull run the temptation is running high.

But this time it is a little different.

Several leading analysts have gone on the record to suggest that the outlook for gold is southwards from here and yet the jungle drums (newswires) remain ominously quiet. What can we make of this and what does this portend for the gold price?

The innumerable factors that have taken gold to a fourfold increase over the last years remain very much in place - and more so. Some factors weigh less heavily but they are more than compensated by others (too many to list and well documented elsewhere) that have grown larger still.

Picking two of the major drivers - systemic risk and inflation - are these less of an issue or more of an issue since the beginning of 2008? We take the opinion that it remains very much the latter.

Estimates of sub-prime losses have risen by nearly 50% according to the IMF - and we are still dealing with the first order effects - how well the corporate and private sector cope with illiquidity in lending are yet to be felt. Inflation - in the US nominally at 4.6% if you look at the CPI which now ignores anything that matters such as food and energy. China meanwhile is nudging inflation rates of 9% and India 7.6%. US money supply is massively expansionary (the US stopped publishing the broad money supply measure M3 in March 2006 strangely) but we can gauge world FX reserves and these have increased 17% annually over the last 10 years.

If we really are back to the 70’s - a period which saw gold rise 16 fold, oil rise 14 fold and sugar rise 47 fold - then the four fold increase to date looks comparatively modest. Gold does funny things when we get negative real interest rates (currently a 2% for holding dollars) and rises of 20% plus per annum (looking back to the period from 1970) are not uncommon. The compounding effect and aided by inflation and we could find ourselves nudging a further fourfold increase before this bull run is over in a few years time. To be precise - that would make it between $3,800 and $4,000 a tonne.

The key question really is how long has this cycle got to run? Kondratieff who developed a theory around a 60 year cycle would probably have suggested we have another 6 years to run before we have worked off the excesses of the last 12 years. Time for some economic medicine and like most tinctures they taste awful, take time to have an effect and failure to do so risks a far worse scenario.

I remain resolutely bullish for gold and see no reason for changing my view at this time. The fly in the ointment for gold is the manner by which it is currently behaving - a bit like ‘old gold’ steady constructive rise then big smack down. Unfortunately, this price action can weigh heavily upon the confidence of those that might otherwise view gold positively.