Gold Targets $1,200 as Central Banks Sales Dwindle

By: Mark_OByrne

Gold’s correction continues and it has fallen for four days in a row now but the long term fundamentals remain very sound. Bargain hunters are likely to reemerge at these levels which should be supportive.

Gold remains up more than 7% so far this year (in dollar terms as per table and much more in euros and sterling) and continues to significantly outperform battered stock markets. With the global economy sinking into a deep recession and possibly even a depression this outperformance looks set to continue in the medium term.

Momentum and technical driven players with speculative short term horizons such as hedge funds are again pressurizing gold however the fundamentals of strong investment demand and anemic supply shall likely see gold well supported between $900/oz and $930/oz. A period of correction and consolidation was clearly needed and this will likely lead to gold targeting the $1,200/oz level in the coming weeks.

While jewellery demand has fallen and scrap supply has increased significantly in recent weeks, this is being negated by the hugely increased investment demand for gold coins, bars, certificates and ETF’s. The increase in scrap supply is due to owners of jewellery selling in order to raise much needed cash. Ironically, it shows that there is no ‘mania’ for gold amongst the “man in the street” at the retail level. Quite the opposite, consumers internationally are selling their gold rather than buying.

Retail investors are clearly increasingly investing in gold as seen in gold coin shortages, rationing and rising premiums and in the surge in demand for certificates and ETFs. However, this increase has come from tiny levels and retail investment in gold remains tiny vis-à-vis investments in equity and bond markets. Also, the physical gold market is such a tiny market vis-à-vis equity, bond, currency and derivative markets that even small flows from these massively larger markets can result in outsize moves up in the gold price.

Importantly, one of the most important sources of gold supply In recent years (both in terms of volume and psychologically) has been central bank supply. This potential huge overhang in the market contributed to gold falling to massively undervalued levels in the late 1990’s (Gordon Brown’s disastrous sales much of the UK’s gold reserves ironically marked the bottom of the market) and has contributed to gold’s very slow and orderly advance in recent years.

Gold has risen some 16% per annum or some 260% in the last 10 years. Without the large potential central bank supply, gold would have more likely replicated the performance of the 1970’s when it rose from $35/oz to $850/oz in just 9 years for a return of some 2,400%.

With central banks becoming increasingly reluctant to part with their gold reserves and indeed some second and third tier central banks becoming buyers (notably the Russian Central Bank and the People’s Bank of China), gold prices look very fairly valued and have the potential to appreciate very significantly in the coming years.

Central banks are rightly concerned about financial, economic and systemic contagion. The German Bundesbank recently clearly stated how they view gold as a an essential monetary asset. "National gold reserves have a confidence and stability-building function for the single currency in a monetary union," the Bundesbank said.

By Mark O'Byrne, Executive Director

Gold and Silver Investments Ltd. have been awarded the MoneyMate and Investor Magazine Financial Analyst of 2006.

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