Expert View: From war to weddings, why gold could glitter again

The easing in tensions that worked against gold may not last
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The Independent Online

Gold prices have been on a roller-coaster ride in the past few months. Having shot up to over $720 per ounce in May, they dived to less than $560 in June, bounced to over $660 in July, and then slumped back to around $570 in September.

This is clearly not a market for the faint-hearted. However, with the commodity clawing its way back to almost $600 over the past two weeks, there are seven reasons why gold could regain its May highs.

1. Seasonal demand. There is a tendency for gold prices to rise at this time of year, which they are now starting to do. One reason for this is the Indian wedding season.

2. Weakness in the dollar. The inverse relationship between gold and the greenback has resurfaced this year, after breaking down late last year. Indeed, the recent firmness of the dollar has contributed to gold's decline. However, we expect the dollar, under the influence of a shrinking interest rate advantage, to fall over the next few months, heading off towards 1.40 to the euro and 2 to sterling.

3. Geopolitical tension. Gold has appealed to some investors as a safe-haven asset in the midst of heightened geopolitical worries. But this was another factor that worked against gold last month, given the easing in the tensions with Iran over its nuclear programme, and the ending of immediate hostilities in Lebanon. This comparative calm may not last, though, as the recent threats from al-Qa'ida to attack targets in Israel and the Gulf suggest.

4. High oil prices. The sharp decline in crude from its August highs, which has been a depressing factor for gold, is also unlikely to persist. The recent absence of supply disruptions cannot be relied upon to continue, and demand is likely to remain firm despite the signs of moderation in US economic growth. In any case, oil producers are hinting that they may cut output to shore up prices if they fall much further from here. The oil-gold link is partly explained by the fact that both have been boosted by geopolitical risk, but also relevant is that oil-producing nations have traditionally been heavy buyers of gold.

5. Central bank selling is abating. After many years of off- loading their gold reserves, central banks have recently been taking a less negative view. Indeed, there have been reports that some are buying, citing the diversification benefits of holding gold.

6. Institutional demand. Gold is also benefiting from an increase in demand among institutional investors, which are seeking to diversify into commodities as an asset class. Although this strategy suffered a blow in the correction in May, when equities and commodities fell together, the development of new indices and futures contracts is fuelling continued expansion of this interest.

7. Producer "dehedging". Another factor supporting the gold price is that producers themselves are taking a more positive view and reducing the hedging of their future receipts by scaling back forward sales.

All this said, the suddenness of the retreat from the highs recorded in May highlights the risks attached to this bullish view. A sudden loss of investor appetite for risk - perhaps because of resurgent fears of higher US rates (after all, gold does not pay interest) or a steeper-than-expected plunge in US economic activity - is certainly possible.

However, while I expect US activity to slow, this is unlikely to turn into recession. With the slowdown will come an easing in inflation fears, and while this won't help investor demand for gold - it has traditionally been seen as an inflation hedge - it should give the Federal Reserve the leeway to bolster both economic activity and investor appetite for risk by cutting rates. If so, gold may shine again.

Mark Cliffe is group chief economist at ING

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