Is Gold's Run Coming to an End? - The Daily Reckoning
The Daily Reckoning by Bill Bonner
On This Day - 24 September 2011
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Is Gold's Run Coming to an End? A  A  A

- By Asad Dossani, Author, The Lucrative Derivative Report

Asad Dossani
Before we begin this article, we'd like to turn your attention to a special Equitymaster WebSummit we published just yesterday. In this short video, we discuss the recent market crashes and global crisis, and how to profit from it. We provide our near to medium term outlook, along with some potential trade ideas. We encourage all our readers to take a look, as we believe it will be useful and informative for you.

Throughout the global financial crisis, gold has always taken the role as a safe haven. Gold is perceived to be an asset that provides strong returns when other assets falter. In particular, the last couple of years have seen large increases in gold prices, when stocks have suffered, and debt crises have engulfed Western economies.

The global crisis and corresponding market turmoil continued this week. In the latter half of the week, stock markets around the world saw significant falls, as investors are increasingly worried that the global economy will slow down. In addition, uncertainty surrounding a potential Greek default has severely dented market confidence.



What was different about this week's market crash (as opposed to previous weeks) was that gold and silver both crashed along with everything else. Previously, gold and silver would both rise due to safe haven demand when markets crashed. So why did gold fall this week? Is this an indication that gold's spectacular run may be coming to an end, at least in the short term?

Although gold crashed this week, it was not an indication of a drop in safe haven demand. In fact, it was just the opposite. Both the US dollar and the Japanese yen saw large increases this week, due to safe haven demand. In fact, much of the safe haven demand this week saw outflows from gold, and inflows into the US dollar.

Gold certainly did not have the same safe haven status as the dollar or yen this week. The real question for investors is whether this will continue going forward. Will it be the case that if the market has another crash next week or the following week, gold will crash along with it? Or will gold regain its safe haven status and continue rising?

To answer this question, we need to understand why gold sold off despite a deteriorating stock market. Essentially, what happened was that investors sold stocks and put their money in US dollar deposits, rather than gold. This explains why the dollar rose and US treasuries rose, while gold fell.

Over the last few months, gold has risen tremendously. Nearly all commentators and analysts have recommended that investors buy gold. And investors have done just that. A large number of investors, both institutional and retail, have been buying gold. So part of the reasons gold did not rise again is that many investors already owned gold, so they were not buying more of it.

In fact, consider the point of view of an investor who is bullish on gold due to the global crisis. As the crisis has been going on for some time, it is most likely that this investor has already bought gold. It is likely that investors who want to buy gold to protect their portfolios have already done so. Thus, even though stock markets continue to fall, there isn't enough new demand for gold.

Thus, the main reason gold sold off despite the deterioration in the global economic situation, was that there wasn't enough new demand for gold. There are few investors who are bullish on gold today but were not bullish a week or two weeks ago. The lack of additional demand ended up leading to a short-term correction in gold.

Given these facts, the short-term outlook for gold is not particularly positive. Unless new demand for the commodity is generated, the price will not rise significantly. Of course, this is only a short-term phenomenon. In the medium to longer term, things may be quite different.

In the medium to longer term, gold will be driven largely by currency debasement, as measured by inflation rates. This is particularly so for US inflation, as gold is internationally traded in dollars. If the Fed's QE policies and other factors end up creating high inflation (which has not yet occurred), then gold will benefit.

On the other hand, if much of the currency debasement does not materialize, then gold could suffer in the medium term. A lot debasement is largely priced in to the gold price, i.e. investors have bought gold with the expectation that high inflation is going to occur in the future. If the next two to three years see low inflation rates globally, then gold is likely to suffer.

To answer our initial question, as to whether gold's run has come to end, our answer can be summed up as follows: In the short term, due to many investors already owning gold, and lack of additional demand, gold's run may be potentially halted. This explains some of the recent falls in gold despite the increase in safe haven demand.In the medium term and longer term, gold prices rising will depend a lot upon whether the currency debasement and high inflation actually end up taking place.

is a financial analyst and columnist. He actively trades his own and others' funds, investing primarily in currency, commodity, and stock index derivative products. Prior to this, he worked at Deutsche Bank as an analyst in the FX derivatives team. He is a graduate of the London School of Economics. Asad is a keen observer of macroeconomic trends and their effects on global financial markets. He is deeply passionate about educating investors, and encouraging individuals to take part in and profit from financial markets. To put it colloquially, he wishes to take Wall Street products and turn them into Main Street profits!

Disclaimer:
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5 Responses to "Is Gold's Run Coming to an End?"

Santosh

Sep 28, 2011

Gold is still healthy for investments. It will be too early to claim gold has lost its steam. Obama has already communicated on cutting deficit. Measures to cut deficit will hamper growth and US can't afford to compromise on growth. Therefore debasement of currency is one way of cutting deficit; i.e US will be pay less than what they borrowed as $ will be depreciated. A depreciated $ will boost gold price up.

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gg

Sep 26, 2011

Despite the fall in last few days, gold is up by more than 40% compared to 12 months ago (in rupee terms). However annual inflation rate has been no where close to 40%.

Might we then conclude that Gold has priced in the next 3-4 years inflation? If so, Gold should, at best, remain range bound over the next 2-4 years. (short-term sentiment or long-term total monetary collapse aside).

Central banks can remove money as well as infuse it. So if they retain some degree of sense and control (debatable), they will rein in the money supply before it causes runaway inflation.

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Hari

Sep 26, 2011

For the Long Term Investor. Please buy some and keep it for long term during this correction. No point in going behind it when the prices are in upswing.

Go for it now with a investment horizon of 20 -25 Years. It takes time from a plant to grow in to a tree. A storm might whither its leaves....but still the metamorphism continues....

No Volatility in markets means no challenge.. all will be equal if they have financial discipline. It is very crucial that one understands the turbulence we are in, withstand it to reap the benefits.

So Buy Gold its is hot only now......

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Rajan

Sep 25, 2011

What a delightfully vague statement !

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Narayanan

Sep 24, 2011

Large investors in stock market bought gold as a hedge. They have sold the stocks causing great fall and consequently their risk in stock market is also reduced. They incurred loss in stock market and the investment in gold is in good paper profit. So they booked profit in gold by selling and their overall portfolio is in profit. As you rightly said their is no fresh demand and many had burnt their fingers by entering the gold rally at a late stage. I dont expect a big rally in gold in the near future.

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