Last week, market attention focused on the increase in gold prices, which marked the US$1000oz threshold for the first time since last March. Various explanations were provided for the upward trend in gold prices. First, fear that the ultra-expansionary monetary and fiscal policies adopted by central banks and governments around the world, particularly in the U.S., might prompt a sharp turn to the upside in inflation over the coming quarters. Indeed, over the last few decades gold has turned out to be one of the most reliable indicators for estimating the inflation trend in the subsequent 12 months. For this reason, the rise of gold prices to a new high would send a warning signal on the inflation outlook for the months ahead, and the consequences would be felt primarily on long-term interest rates. Nevertheless, inflation concerns appear to be overdone as the inflation outlook for the coming months does not look particularly alarming, given the low capacity utilization and the continuation of the deleveraging process by leading international economies. The expected inflation rate, calculated as the difference between the 10-year nominal rate and the real rate on Treasury TIPS, has now steadied around acceptable levels and is in line with the historical average.
Paradoxically, the rise in gold prices could be evidence that the market should begin to price in a deflationary scenario. One of the main lessons of the Great Depression in 1929, in fact, is that gold may be a hedge against the currency devaluation imposed by the monetary authorities during the most severe deflationary phases. Despite signs of an economic recovery in recent months, worries that the economy might get into a prolonged deflationary cycle have become increasingly acute. Indeed core inflation could continue to fall for several months even under the most optimistic hypothesis that the US pulls itself out of recession. The slowdown of core inflation might even deepen should the W-shaped economic scenario much-feared by some economists materialize.
Therefore, the reasons for higher gold prices should be found elsewhere. One possible explanation may offered by the purchases of gold made by the Chinese government. In an interview with the UK daily newspaper at the Ambrosetti Workshop in Cernobbio, a Chinese government official said that the country’s authorities are concerned about the repercussions of the ultra-expansionary U.S. policy on the US Dollar and pointed out that gold is a viable alternative to the greenback, although market purchases must be made with caution not to push higher gold prices. His words appeared to confirm that China aims to increase the proportion of gold in its reserves, hence persuading traders that gold prices are likely to go up in the medium term.
Investors’ behavior might offer another reason for the rise in gold prices. Following the investment boom in 2007, commodity investments were stopped in 2008 but recovered in the first half of 2009 (as highlighted in a recent report by Macquarie) thus favouring a rebound in commodity prices from the depressed levels last seen at the start of this year.
Finally, gold prices might have been driven higher by the belief of major gold producers that the upward trend in gold prices is set to continue into the coming months. During the week, in fact, Barrick Gold, the world’s No.1 gold producer, unexpectedly announced its plan to spend $5.6 billion in the third quarter to close out its hedge book. The closing out of Barrick’s hedge book is likely to bring further pressure on prices and forcing competitors to implement the same move.
Whatever the real reason behind the gold prices increase, most investors believe that gold prices are highly likely to mark and leave definitively behind the US$1000oz threshold. A recent survey conducted by Bloomberg showed that 10 analysts out of 12 believe that gold can exceed the record high of US$1033oz hit in March 2008 in the short term. Some analysts also believe that gold prices will likely continue to follow their upward trend in the months to come. As an example, Citigroup’s technical analysts in a report published in late August have estimated that gold may go up to US$1190oz and reach US$1300oz by the end of this year.
Institutional investors looking for a further increase in gold prices include CMC Markets, with a year-end target price of US$1200oz, and Investec Asset Management, which sees gold rising to US$1150oz. By contrast, Heraeus Precious Management sees gold prices nearing US$1050oz in the short term but retreating to US$700oz by year-end.
Anticipating the trend of gold prices is no easy task. Therefore, holding the precious metal seems to be an advisable option at this time of year because of the high uncertainty surrounding the economy and with a view to protecting the portfolio risk exposure.