Gold is challenging $900/ounce and can go higher, but it really ought to go lower first if strength is to be sustained.
Author: Rhona O’Connell
Posted: Monday , 14 Jan 2008

LONDON - On January 21, 1980, gold recorded its then record high fix of $850, as a result of the Hunt Brothers' attempted corner of the silver market, plus the second oil crisis, the invasion of Afghanistan and the hostage crisis in Iran.
Any of this sound familiar?
This time we are lacking the silver market manipulation, but we have renewed bearishness for the dollar, not only due to tensions in the financial sector that are resulting in increased risk aversion, but also for the more basic fundamental reasons with respect to interest rate differentials; German 10-year rates are currently 20 basis points above those in the U.S. The differential has been as high as 37 basis points and it looks as if the gap will continue to widen.
Inflationary concerns are less important this time than they were in 1980 - 28 years ago the US CPI peaked in March at just less than 15% - but the dreaded word "stagflation" has been on the lips of a number of economists and this, too, supports the investment case for gold.
But should we perhaps be a little cautious here?
There is a degree of euphoria among some of the market observations, certainly in the lay press and this is often something of a warning signal. While there is little doubt that all the conditions remain in place for a further increase in the price of gold in the medium term, the latest move has developed in relatively thin market conditions and the market is looking overbought. Physical demand is waning and there is plentiful stream of scrap supply coming through in India.
A correction in price would be a welcome development of the overall stability of the market, as the majority of the buying has come from the professional sector. The physical market is, for the longer term, a strong one, but the recent volatility in price will certainly deter buyers for a while yet.
In the first 10 days of trading in January, gold has traded in a range between $834 and $898 (on an intra-day basis), or almost 8%. The increase since the latest leg of the rally got underway, which was in the week before Christmas, is $105 or just over 13%, in only three weeks. While the dollar has obviously been a key driver in the move, the price in euro terms has risen over the same period by almost 10%. This looks worryingly like too much, too quickly.
The physical market in January tends to be dominated by the onset of the Indian Wedding Season, along with the Chinese New Year. The former is due in the middle of January and the latter falls on 7th February, and between them they form an important part of the physical market. There is no specific trend that can be displayed in the quarterly figures for physical demand as they are clearly responsive to price, but from 2003 to 2007, inclusive Greater China and the Indian Subcontinent have between them accounted for an average of 37% of worldwide jewellery and investment bars.

The first quarter of the year, worldwide, is not typically the strongest quarter of the year; that position is held by the fourth quarter, which includes a number of Indian and Middle Eastern festivals plus the Christmas season. With European demand usually falling sharply in the first quarter, the demand for jewellery and investment bars has, on average from 2003-2007 inclusive, dropped by 189 tonnes between the fourth quarter of one year and the first quarter of the next.
The recent volatility in price suggests that physical demand for gold for the imminent Wedding Season and New Year will struggle to reach the levels enjoyed in 2007. The quarterly demand for jewellery and investment bars during that period was 643 tonnes, compared with 611 tonnes in the first quarter of 2006.
In simple monetary terms (i.e. working just on the basis of the quarterly average and the tonnage of contained gold), the value of the gold bought in Q1 2007 amounted to $134.5 billion, a 24% increase in the dollar expenditure in the first quarter of 2006. With the dollar price of gold currently 43% higher than at this time last year, the [Chinese] renminbi price up by 31% and the [Indian] rupee price by 25%, the prospects for a strong revival in physical demand look slender.
Recent trading patterns on COMEX show that at the end of December, the latest date for which full data are available, the combined speculative positions on COMEX were 1,014 tonnes, compared with total open interest of 1,685 tonnes, or 60% of total. The net speculative long on COMEX was 742 tonnes, just shy of the record level of 747 tonnes on 6th November, when the sector was scoring intermediate highs. Obviously COMEX is centrally-cleared and for every long there is a short, but the speculative length in the market is worrying and it is in the gift of industrial users to stand away form the market when liquidation develops and wait for prices to be offered down.
There is little doubt that the fundamentals are in place for further medium term strength, but a pullback really would be most welcome if these higher levels are to be sustained and underpinned.