We would be surprised to see a sharp correction lower in the gold price ahead

With gold having reached our target of $1,300, we expect support to remain in place, mainly from investment demand. But elsewhere in the market, strong resistance to a higher gold price is building.

Macroeconomic factors remain positive for gold investment demand. 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. In recent days, the yield on the 10-year US inflation-linked bond declined to well below 0.70%, implying that the market expects US
real interest rates to average a mere 1% over the next 10 years. A lower implied real yield favours gold investment. Furthermore, our measure of global liquidity (“Fed balance sheet plus global foreign reserves excluding gold”) continues to rise, supporting the current
high gold price (see adjacent graph).

In August, when the physical market supported the gold price, we are now witnessing increased resistance from the physical market. Traditionally, Q4 sees increased demand from the jewelllery sector, but demand is very low right now and there are rising volumes
of scrap gold coming to market. At the same time, net speculative longs on COMEX are close to an all-time high, at 901 tonnes, making us even more wary of a short term correction in the gold price.

We would be surprised to see a sharp correction lower in the gold price ahead of the FOMC meeting next month as we’d expect further quantitative easing. We would therefore buy gold on dips until that time. We remain constructive on gold in 2011. However, we believe that gold may see a sharp correction lower towards year-end 2010 as seasonal jewellery demand dies away and speculative interest unwinds.

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