GOLD'S ACHILLES' HEEL
Chris Temple, Editor/Publisher
The National Investor
Thursday, June 10, 2004
Oil prices recently hit all-time nominal highs in excess of $43 per barrel. The Middle East remains a tinderbox. Washington has warned us anew that it fears a major terrorist attack against U.S. interests-perhaps even again on U.S. soil. Even absent oil price pressures, inflationary expectations in the United States have been steadily on the rise.
Yet in spite of all of this and more, gold has been unable to get out of its own way. The uncertainty and volatility that have bedeviled virtually all markets over the last few months certainly hasn't helped gold, with traders unsure whether they should zig or zag. But there's a far bigger factor that currently has gold acting tentatively; and one unlikely to go away any time soon.
To recap first, after plunging precipitously in April down to near $370 per ounce the yellow metal has since managed to bounce a time or two, courtesy of the recent softening in the dollar. However, as you see here, gold remains-similarly to the major stock indices, as I point out in my current issue-in a descending channel, and has noticeably been unable to break both out of it, as well as back above its 50 and 200-day moving averages, which have just converged.
Fundamentally, the news for gold recently has not been all that bad. According to a recent report from the World Gold Council, physical demand was brisk during the first quarter; a trend that appears to have continued into the second. The report pointed out that first quarter consumer demand (led by India and the Middle East) for gold rose by 12% in tonnage terms and 30% in dollar terms from the prior year. Industrial demand also rose, by 8% in tonnage terms and 26% in dollar terms. Council C.E.O. James Burton pointed out that, "In the face of a 55 percent rise in the dollar gold price (from a year earlier)... we would have expected consumer demand to recede. (So) the (new) money flowing into gold ... demonstrates a positive underlying trend."
As I pointed out as early as last November, however-and have reiterated more than once since then-the "killer" has been the always fickle investment demand for gold, which since late last Summer has been the main driver of the gold price. The WGC report revealed that net institutional investment demand for the metal stagnated during the first quarter; a situation that "may in fact have intensified," it added, in the second due to speculative funds unwinding their previous positions, as well as being uninterested in establishing new ones to any great degree.
Predictably, gold's lethargy together with a broader weakness in metals has kept mining shares hemmed in as well. As you can see here from a chart of the HUI, this closely-watched index has also failed of late to push back above its 50-day moving average.
Sentiment-which currently is lousy-may not change any time soon. Similarly to stock traders, investors are just as preoccupied right now in asking what more could go wrong for gold. Among other things, there are worries about new European sales that have recently been announced, in part to help countries there (most notably France) raise some cash to alleviate budget deficits. Back when the extension of the Washington Agreement was announced, the additional sales were taken in stride by a then-strong gold market. Upon further reflection, though, some are now more worried about what the prospects for such sales will do in the near term to a much weaker market.
We also can't ignore the substantial technical damage that was done in April to the precious metals sector; damage that will take longer than this to repair. It has not been encouraging that gold (and silver) have failed so miserably to mount anything more than oversold bounces even as oil prices were surging higher.
In short, gold will for a while longer remain hostage exclusively to currency movements, chiefly that of the dollar against the euro. Until that situation clears up and the greenback more forcefully reasserts (or is made to reassert) its secular bearish trend, precious metals will languish. Gold's Achilles' heel-investment demand-which over the last several months of 2003 and early on in 2004 gave us soaring prices as short-term players piled on to what was already a two-year bull market, is now working against us.
We also cannot ignore the ramifications of coming Federal Reserve actions and policy statements, which could in the near term cause the dollar to rebound and, consequently, gold to fall even further. It would serve the Fed quite nicely, as it seeks to raise interest rates as little as possible, if gold were to stay docile. Whatever it does where short-term rates are concerned, make no mistake that the Fed's actions and words will be carefully crafted so as to keep both long-term interest rates and gold relatively in check. We saw a perfect example of this earlier in the week, when Chairman Greenspan's more hawkish, if only momentary, vigilance about future inflation temporarily arrested a fresh rise in interest rates, and caused gold's price to drop by some $7.00 per ounce.
Now, none of this means that the Fed will eventually prevail; in fact, I'll tell you that it will not. Sooner or later, the long-term bearish trend for the dollar will reassert itself. A slowing economy as we move toward and then into 2005 will throttle tax receipts anew, exacerbating the budget and current account deficits. Greenspan's ongoing efforts to keep the world awash in dollars, even if it raises the price of those dollars a little, will benefit gold anew. At some point this will bring long-term investors back into gold, who will then be joined by the "hot money." In the end, gold will see new bull market highs.
Between now and then, however, don't be a bit surprised if gold first trades at or below $350 per ounce, before we see $450 (or higher) somewhere down the road.