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Capital Markets

High gold prices are sustainable

Quantitative easing’s poor results, fears of another recession and the crisis in the UK, US and eurozone mean a soaring gold price is here to stay

 

Gold prices are not a bubble, strategists tell Euromoney. Rather, they point to a loss of confidence in quantitative easing; fears of another recession; and the crisis in central banks’ abilities to manage the economies of the US, UK and eurozone as reasons that gold will stay above $1,800 for the rest of the year.


Gold soared to around $1,875 on the spot market at mid-day today, up 2.8% from yesterday. Comex forward futures contracts also increased to $1,870 – another historic rise as investors abandoned stocks for safer asset classes.


“Given the scale of capital destruction that has yet to be acknowledged and which quantitative easing with its fiat money has in effect tried to cover up, the distrust of western paper money continues to run high. This is not only a financial sector crisis, but also a crisis of overall governance in the eurozone, the US and the UK,” says Marc Ostwald, financial markets strategist at Monument Securities. “It is difficult to argue that gold is in a bubble, even if the one-way charge into gold has bubble-like qualities. It would require a sharp rise in money rates and bond yields to attract money away from gold, as the opportunity costs of holding an asset that does not pay interest or a dividend is very low at the moment; a sharp rally in equities and/or real economy commodities would also prompt some profit-taking.”


Joshua Raymond, chief market strategist at City Index, says: “Gold continues to be the safe-haven asset class of choice among investors; the precious metal has bullish momentum at present with long-term support levels holding and resistance levels quickly being broken. While its fantastic rise in price is something one would attribute to a bubble, continued economic uncertainty is only likely to support gold prices further.”


The long-term sustainability of gold prices is compounded by fears of recession, say the analysts.


“I’m bearish on the economy and I don’t think the gold price is tied to debt,” says Roger Nightingale, strategist at Agency Partners. “Debt is irrelevant. It is more because the economy is in desperate trouble and investors are realising this. Investors are also realising that the central banks’ abilities to manage money supply and to direct it into the stock market is not happening and their investments need to be directed in the safest options – gold and bonds. While some people say they hate bonds and gold because they are over-valued, they are by far safer options to invest in, compared to stocks. With the rush of money going into these asset classes, it will push up the price and keep it at that level for as long as the economy is in the situation it is now.”


Nightingale adds: “If money is tightened, although I don’t see this happening this year, there will be an even bigger fall in equities, which will reflect in the gold price as well.”


Global stocks took a tumble over the last week as investors continued to pull their money out on the back of recessionary fears following a raft of weak economic data.


The Nasdaq had fallen 5.22% by lunchtime today, while the S&P500 fell by 4.46%. European equity indexes also traced lower, with the DAX falling the furthest – 3.88% – and the FTSE100 slipping under 5,000.


“When we see sharp falls such as the ones over the past few weeks, there is always the potential for a bounce back,” says Raymond. “But these falls are being driven by uncertainty and fear that is being justified by weak economic data and so this is also threatening broader sentiment. Also pivotal is that despite the rallies we have seen, they have not helped to repair market confidence and have been short-lived and choppy in nature.”


Exchange-traded-fund management firm ETF Securities reveals that $0.75 billion of investment moved into its gold exchange-traded products over the past month, which is ‘head and shoulders above other commodities, as debt, growth and equity market scares have reverberated through global asset markets,’ according to the firm.


Daniel Wills, senior analyst at ETF Securities, adds that gold’s special standing as a perceived store of value and an alternative to paper currencies mean that its fortunes are really tied to confidence in the purchasing power of cash.


“The health of the financial system and government finances, interest rates and inflation are thus paramount to the outlook,” says Wills. “Will governments be able to sustainably serve the debt hangover from post-credit crisis stimulus? Do banks have sufficient capital to withstand any downgrade in government finances? Is QEIII back on the table in the US, with further acceleration in money supply even as inflation remains elevated? How fast will interest rates and yields on risk assets rise should growth recover? These are among key questions investors need to ask when considering the sustainability of the recent vault higher in gold prices.”


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