2011-01-15

Gold reaching $1,500 in H1:2011, short-term the metal looks set to struggle

Gold is failing to make new highs despite fairly strong physical demand in India and Asia. Investment demand is lacklustre. While we still see gold reaching $1,500 in H1:2011, short-term the metal looks set to struggle.

Empirically, we find the long-term causal drivers of gold are global liquidity and real interest rates (see Commodities Insight: Global liquidity and real interest rates support gold of 11Aug’10). We define global liquidity as the Fed’s balance sheet plus global foreign
reserve holdings (excluding gold). Gold trades around the long term trend these two variables provide. All other factors we view are short-term drivers. Lately, gold has diverged by some margin from the long-term trend provided by these causal drivers. Divergence by gold from this
long-term trend is not unusual, but the speed, size and timing of its divergence coincide with a period in which risky assets are finding support.

We find a gold price closer to $1,340 to be consistent with current global liquidity levels (refer to figure). That is, we believe gold has moved ahead of its casual drivers. This, combined with the fact that post-China’s New Year (which is at the beginning of February) physical demand may tail off, short-term upside for the metal may be capped.

We see strong technical support for the metal between $1,340 and $1,347. At the same time global liquidity is set to grow further this year which should push gold eventually higher. We further believe in 2011 low policy rates are here to stay despite the risk of higher inflation – as a result short-term real interest rates are set to remain very low. Low real interest rates
are supportive of gold. While we remain bullish on gold into 2011, we expect the metal to average only $1,370 in Q1:11 but move higher in Q2:11. We expect gold to average $1,430 this
year.

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