Where’s the Gold Market Headed in the Short Term?

Gold Market StocksFor 43 years, GFMS, the world-renowned precious metals consultancy, has been publishing its gold survey, which is considered one of the most authoritative annual surveys of the gold market in the world. According to GFMS, gold and other precious metals predict further gains in investment and gold prices, building on the record-performing 2009. However, there are also concerns about the strength of the gold rally in the second half of 2010, considering that jewelry demand remains weak.

According to GFMS, in 2009, investment demand surpassed jewelry production for the first time since 1980. In effect, gold investments more than doubled last year to almost $60.0 billion, in part because of the declining U.S. dollar, but there were other powerful price-driving factors. Fears over quantitative easing — that is, fears over world central banks’ indiscriminate increase of money supply — played a significant role in gold investment activity in 2009. Additionally, mounting counterparty risks also contributed to gold’s upward momentum, rallying the gold price to record highs in early December of last year. In fact, it was during the closing months of 2009 that the complexity of overall investment reached a boiling point, particularly as buying of physical gold and gold exchange-traded funds (ETFs) rallied among ordinary investors and as more speculators focused on the futures market.

GFMS further added that 2009 to gold was more than just about investment activities. For example, the gold market had to address the issue of sharp declines in jewelry sales, which achieved record lows not seen in over two decades. The volumes that had peaked in 1997 have been almost cut in half in 2009, as the Great Recession in conjunction with an environment of still higher prices wreaked havoc on all kinds of consumer spending.

At the same time, scrap metal supply rallied, piggybacking on elevated prices and panic-selling under the profound pressures of global economic trauma. As a result, the demand for scrap metal reached record highs in 2009, making up for almost 40% of the world’s total supply.

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Based on its precious metals’ survey, the consultancy stated that the complex relationships of these forces were at their most dramatic in the first quarter of 2010, fuelled by strong forward momentum in precious metals’ prices during the fourth quarter of 2009. Furthermore, GFMS said that getting the real picture very much depended on having a thorough look at what was happening in the physical market. Meaning, as scrap metal demand skyrocketed in the first quarter of 2010 past not only jewelry demand, but also mine production, it should have not come as a surprise to anyone how investment activities managed to speed by the $1,200-per-gold-ounce mark as 2009 drew to its close.

In its latest survey of precious metals’ markets, GFMS also accounts for events that had transpired in the government sector, where net sales dropped a staggering 80%. This development is primarily attributable to lower sales by European central banks. GFMS also makes a mention of the importance of India’s purchase of 200 tons of gold from the International Monetary Fund (IMF), which gave a huge boost to the market and which has sent a clear signal that central banks’ attitude towards gold is on the cusp of dramatic change.

As a direct consequence of India’s IMF gold purchase, investors responded so bullishly in September that most mining companies still holding onto a hedge book immediately started unwinding their hedges. Unfortunately, there are still plenty of hedge books out there, totaling over 250 tons according to GFMS estimates. That much gold cannot be easily replicated with the outstanding books at year-end, regardless of how strong supply levels are from various markets.

Having in mind that GFMS is forecasting higher mine output and minimal de-hedging in 2010, the implication could be that the consultancy has become somewhat bearish on gold. However, the message in the 43rd GFMS precious metals survey is that, while in the short-term, prices of precious metals, gold particularly, are likely to come under pressure, gold fundamentals are improving and investors have no good reason to start either minimizing or liquidating their gold exposure.

Looking ahead, upward price momentum for the remainder of 2010 is likely, because levels of investment activity are as strong as ever, in large measure because of exceedingly high levels of sovereign debt and the potentially long-term inflation threat looming in many markets. On the other hand, GFMS also warns that, since there are no immediate signs of where fresh investment is going to come from, nor are there macroeconomic factors out there strong enough to create another extraordinary upward price movement, the next rally in gold might take longer to materialize. According to GFMS, the precious metals market could be entering the end game now, although there might still be two years or more for it to develop. The only way to avoid a steep correction in the precious metals market and to bring it back into equilibrium would be to boost jewelry demand and to scale back the demand for scrap.