European debt is at the forefront once again

Gold is pushing towards its all time highs of $1,265. Our target for gold remains $1,300 in Q4:10.
We see the long-term causal fundamental drivers for investment demand in gold as liquidity and long-term real interest rates. Both support a higher gold price (refer to Commodities Insight dated 11 Aug’10).

Global liquidity is ample and real interest rates are low; as a result, investment demand for gold is likely to remain in place. Gold’s relationship with liquidity is confirmed visually (refer to figure) as well as empirically. We measure global liquidity as the US Fed balance sheet plus global foreign reserves holdings excluding gold. YTD, our measure of global liquidity is up 10%. The gold price is up 13% YTD. As ETFs are utilised by institutional and retail investors, they are an important vehicle for liquidity and low interest rates to be channelled into gold demand. Given robust global liquidity, it is not surprising that total ETF holdings now stand at around 2,030 tonnes. Since the start of 2009, gold ETF holdings have increased by almost 72%. In the past two years, ETFs have executed few liquidations despite increased market volatility.

The relationship between global liquidity and commodities indicates that gold is a main beneficiary. In fact, gold has been tracking global liquidity. We expect the Fed to keep interest rates unchanged for most of 2011 and, thereafter, to hike rates slowly. The 10-year US inflation-linked bond yield is around 1%, indicating that the market expects real interest rates to average a mere 1% over the next 10 years. The current yield is well below that of 1997, when the real interest rate implied by inflation-linked bonds was at 4%. The current yield favours gold investment.

We believe that global liquidity will keep rising as emerging markets specifically, further expand their foreign reserve holdings. However, we expect it to slow in 2011 and 2012 — to only 8% and 5% respectively. However, until either real interest rates start to rise or liquidity declines, we believe that gold’s investment case remains intact.

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