Gold's fate linked to dollar movement - The Hindu

Courtsey: G.Chandrasekhar, The Hindu

Mumbai, Dec 21 Even 2008 draws to a close, it is becoming increasingly clear that all commodities market participants - traders, investors and others – will remember the year for the extraordinary price performance, gyrations and volatility.

Commodity prices - be they of energy, metals or agriculture - not only hit multi-year record highs at one time, but they also plunged to great depths in a matter of weeks, if not days, precipitating a crisis.

Quite contrary to the first two quarters, in the last quarter, producers, consumers, traders and investors faced daunting challenges in the wake of sharply declining demand, rising inventory and collapsing prices.

Speculators exited the market in a hurry, removing a considerable amount of speculative froth that had developed in many commodities during the bull-run.

What started as global slowdown degenerated into a recession, at least in industrial economies such as the US and the Eurozone. Financial and economic conditions have turned grim. Currency fluctuations, especially that of the dollar, impacted market prices.

There is a widespread expectation that notwithstanding continuing recessionary conditions, commodity prices may largely be bottoming out. From the current levels, further downside risk to prices - crude, base metals, agriculture - seems to be limited. The crisis of confidence continues and may stay for some time.

However, when the process of economic recovery begins, hopefully in the third quarter of 2009 as a result of a series of bailout and stimulus packages, investor confidence may return to the market. Until then of course one must reckon with volatility.

There is also the strong possibility that sizeable output cuts that have been made in crude, steel, copper, aluminium and others will store problems for the future and begin to create a supply bottleneck when demand returns.

However, for the time being cash is still king and poor demand outlook remains the top of market concerns.

Gold
With the dollar rapidly weakening against the euro last week, gold prices got a boost and decisively moved above $800 an ounce. Physical demand at lower levels amid less volatile conditions generated support.

On Friday, in the London spot market gold PM Fix was at $835.75/oz, down from the previous days $855.25/oz. Silver declined too to $10.61/oz (AM Fix) from $11.29/oz the previous days.

Going forward, the yellow metal will be clearly influenced by the strength or weakness of the greenback. If the dollar should weaken further, it should provide a strong base for the metal to move higher. However, foreign exchange experts are of the opinion that currency movements in the next few weeks may cushion gold’s upside.

Interestingly, as the prices ruled above $800/oz, many investors exited their long positions on the Comex. No wonder, net fund length is near the lows of June 2007.

According to technical analysts, gold’s uptrend is erratic. It may be tough for the metal to breach $880 levels. The market is holding above short-term support of $829.

Below $829 would warn of a deeper pullback towards $782, though even in this scenario the choppy uptrend from October lows is likely to remain dominant force. The medium term view is largely neutral within $700-930.

Base metals
After sliding to fresh lows, base metals prices rallied on news that the US government will give an emergency loan of $17 billion to the US car manufacturers. Other wise, it was terrible week for base metals, with the exception of aluminium and zinc which ended the week higher. Lead prices fell by over 16 per cent week-on-week and tin fell by over 10 per cent.

Outlook for the base metals complex over 2-3 quarters into next year is grim with recessionary conditions and lack of demand growth the main theme. Construction sector and automobile sector, two important metals consuming sectors are facing serious downturn in demand. Inventories are rising. Many producers have responded quickly with output cuts.

Copper is the metal with the largest downside potential from current levels. Copper prices are is still above production costs and miners are still making money. So, there could be further cost-related cutbacks, experts assert.

On the other hand, aluminium, nickel and zinc prices have all fallen very close to weighted average production costs, experts point out, adding copper could dip near to this level at $2,100 a tonne.

Notwithstanding short-term weakness, the longer term outlook for base metals appears positive. This is because not only is output being cut, new investments are being put on hold. This will squeeze supplies when demand returns to the market. There will be supply constraints with concomitant impact on market prices.

Crude
Despite announcement of OPEC production cut and drastic decisions in the US monetary policy, crude prices dipped below the psychological $40 a barrel. Demand side concerns have been top of the markets mind. There are as yet no signs of demand revival. The financial crisis and growth concerns may continue for longer time than imagined earlier.

Experts, however, believe, from the current levels, the downside risk to crude prices is limited. Indeed, they are talking about the possibility of over-tightening of the market in the medium term. The supply performance of non-OPEC sources is being closely watched.

Oil @ 30 BBL by March 2009 - Goldman Sachs!!

The continued deterioration in global oil demand has compelled us to again lower our oil price outlook for 2009 to an average of $45/bbl from $75/bbl previously, though we see a growing number of signs that oil markets have entered the bottoming phase of the cycle.

Despite our lowered oil price deck, this is not a call that we are incrementally more bearish on Energy equities. Our global energy team is, however, continuing to stick to a defensive posture within the Energy sector in terms of our top picks, though we have gained comfort in recommending select higher-beta stocks that we might call “offensive defensive” ideas (primarily hedged E&Ps with transformational growth opportunities).

We think a move back to high-beta names that would benefit from a future rally in oil prices is still several months away, pending greater confidence that demand is no longer deteriorating and supply is on-track to decline sharply. The latter we think requires a longer period of oil around $40/bbl (or lower) than we have currently seen; demand globally also shows no signs of improving.

We think that the sharp and sudden collapse in global oil demand exceeds OPEC’s ability to, on its own, balance markets, and necessitates sharply lower non-OPEC crude oil supply.

Unlike OPEC, we believe non-OPEC producers will reduce production and sharply cut capital spending only if cash flow is sufficiently weak, which we believe is the case at oil prices in the $40-$50/bbl range.

However, because there is a lag between capital spending cuts and evidence of lower production—and demand is incredibly weak right now—oil prices may need to fall further to levels that stimulate non-OPEC producers to accelerate activity declines and possibly even shut in production, which we think will occur at oil prices around $30/bbl.

While global oil demand is very weak and the duration of demand weakness is unclear at this time, we believe oil supply will collapse if prices remain below $40/bbl for an extended period of time (6-12 months or longer) suggesting we are likely to have entered the bottoming phase of the cycle.

• Oil prices are now meaningfully below the $60/bbl level at which the average company earns a cost-of-capital return on longterm investments based on current costs; capital spending reductions have begun.

Oil prices have traded near the $40/bbl level below which we think short-cycle activity will be sharply curtailed, which should accelerate near-term declines in supply.

• Industry returns on capital are near historic trough levels at a $45/bbl WTI oil price.

• The WTI forward curve is in “super contango” that historically has coincided with the weakest portion of the cycle.

What is not clear yet is how long the bottoming phase will last. Global economic conditions are the weakest the world has seen since at least the early 1980s and global oil demand is declining at an accelerating rate. In our view, the duration and depth of the downturn will be decided by the interplay of global oil demand weakness and non-OPEC supply declines.

Global oil demand has weakened to the point that OPEC cuts alone are unlikely to return the market to balance, with greater declines in non- OPEC supply now required.

In terms of gaining confidence that a bottom is at hand and a recovery possible, we would need to see the following:

• Demand: A deceleration in the rate of global oil demand declines is critical (no signs yet).

• Non-OPEC supply: A sharp reduction in short- and long-term capital projects is required (early signs emerging).

• OPEC supply: It will be important for OPEC to announce additional cuts at its December 17, 2008 meeting in Oran, Algeria in order to gain confidence that OPEC’s “Big 3” of Saudi Arabia, Kuwait, and UAE are on-track to reduce production by the 2 mn bbls per day.

Gold as an Investment alternative!!

Gold has got lot of emotional value than monetary value in India. India is the largest consumer of gold in the world. In western countries, you can find most of their gold in their central banks. But in India, we use gold mainly as jewels. If you look at gold in a business sense, you will understand that gold is one of the all time best investment tool. My dear readers, today I would like to discuss on investments in gold and its potential.

I don،¦t think that I need to give you the definition of gold, because everyone is familiar with gold and in India almost everyone use gold in their daily life. Gold is one of the safest and low risk investment tools in the world and obviously in India also. Gold can be readily bought or sold 24 hours a day, in large denominations and at narrow spreads. This cannot be said of most other investments, including stocks of the world،¦s largest corporations. Gold proved to be the most effective means of raising cash during the 1987 stock market crash, and again during the 1997/98 Asian debt crisis. So holding a portion of portfolio in gold can be invaluable in moments when cash is essential, whether for margin calls or other needs.

Recent independent studies have revealed that traditional diversifiers often fall during times of market stress or instability. On these occasions, most asset classes (including traditional diversifiers such as bonds and alternative assets) all move together in the same direction. There is no ،§cushioning،¨ effect of a diversified portfolio ،X leaving investors disappointed. However, a small allocation of gold has been proven to significantly improve the consistency of portfolio performance, during both stable and unstable financial periods. Greater consistency of performance leads to a desirable outcome ،X an investor whose expectations are met.

Indian Gold Market Current Scenario:
Size of the Gold Economy: more than Rs. 30,000 crores
Number of gold jewelry manufacturing units: 1,00,000
Number of people employed: 5,00,000
Gems & Jewellery constitute 25% of India،¦s exports about 10% of our import bill constitute gold import.
Number of banks allowed importing gold: 15 (While recently this has been liberalized, detailed notification is awaited)
Official estimates of the stock of gold in India: 9,000 tons
Unofficial estimates of the stock of gold in India: 12,000 ،V 14,000 tons
Gold held by the Reserve Bank of India: 358 tons
Gold production in India: 2 tons per annum.

Demand for gold in the Indian Market:
India has the highest demand for gold in the world and more than 90% of this gold is acquired in the form of jewellery. Following are the factors influencing the demand for gold.

„« The movement of gold prices is one of the important variables determining demand for gold.
„« The increase in the irrigation, technological change in agriculture (through mechanization and high yielding varieties), have generated large marketable surplus and a highly skewed rural income distribution is another factors contributing to additional demand for gold.
„« Black money originating in the services sector, like real estate and public sector, has contributed to gold as store of value. Hence income generated in these service sectors can be treated as a determining variable
„« Since bank deposits, unit trust of India, Mutual funds, small savings, etc are alternative avenues for investing savings, the weighted return on these alternative assets can be considered as another influencing factors.
„« Demand for gold also depends upon prices of other commodities. When there is an increase in general price level, it has two effects: first it reduces the purchasing power available for acquisition of jewellery and secondly, it reduces the real return on gold. It has depressing effect on the component of demand in both ways.

Inflation redistributes incomes in favour of non-wage income earners, leading to more skewed income distribution. With incremental income of non-wage earners, the demand for gold as a store of value can be expected to rise.

Supply of Gold
The main economic effects that arise from the changes in the supply of gold can be seen against the quantum of gold that is already in existence in the economy. The supply of gold is not up to the requirements as the production of gold is also coming down and demand for gold is going up very sharply.

Gold as an Investment Option:
Gold as an investment tool always gives good returns, flexibility, safety and liquidity to the investors. Therefore as a financial consultant my advice to you all is, kindly allocate a portion of your portfolio for gold investments. Practice the habit of buying at least one gram of gold every month.