Posted On Monday, Mar 15, 2010
Recently the price of gold seems to be under pressure, showing a decline accompanied by high volatility. Two major reasons have been cited for this downward trend:
However, the above factors should have a short term effect and the resultant weakness should be bought into.
Let us discuss the above mentioned factors in detail:
Recent issues regarding mounting debt and higher deficits in many countries in the Euro Zone have led to a fall in the Euro currency vis-à-vis the U.S dollar. But, the fact remains, that the U.S economy is no different and is in a debt league of its own with rising deficits and increasing total debt. Hence, only because the sovereign debt issues of Greece have been highlighted, the dollar has seen appreciation, with many falsely citing it as a "safe haven" currency.
Going ahead, the high amounts of debt in the U.S will have to be monetized, and this may result in a devaluation of the dollar. Since the dollar is appreciating only due to the weakness in its alternative counterparts, its current strengthening should be only for the short term.
IMF recently announced that it would soon initiate the on-market phase of its gold sales program. This plan to sell 403.3 tonnes of gold has been well known by the market and debated by the media for many months now. Also, we are aware of the RBI buying almost half of the gold for sale followed by further purchases from Sri Lanka and Mauritius. Prior to the current announcement, 212 tonnes of this gold had already been sold to central banks, leaving a balance of 191.3 tonnes. (Source: IMF)
The next phase is about selling this 191-tonne balance in the open market in a way that minimises disruption, which probably means that the sales will be spread over time. However, as stated by the press release by IMF, this does not preclude further off-market gold sales directly to interested central banks or other official holders.
It is important to understand that such gold sales declarations by IMF or any other central bank can be expected to cause short lived psychological reactions as it initially gives an impression of more gold in the market. However, when we put it in perspective and analyse the impact, it appears very insignificant when compared to the overall size of the market.
The relative insignificance of the proposed on market gold sale immediately becomes apparent once it is realised that 191 tonnes is less than 0.2% (one fifth of one percent) of the total above-ground gold supply. Also, developed world central banks used to sell gold onto the open market under the umbrella of "Central bank gold agreement" and that too of a much higher quantum than that proposed by IMF. Average Central bank gold sales since 2000 to 2009 have been 444 tonnes per annum. (Source: World Gold Council)
An average of 650 tonnes of physical gold changes hands via the London Bullion Market Association (LBMA) every day. In other words, the total amount of the IMF`s currently-planned sale equates to only a few hours of LBMA trading. (Source: LBMA)
The biggest gold ETF in the world, SPDR gold trust holds more than 1100 tonnes of gold. All the gold ETFs combined hold more than 1700 tonnes of gold. (Source: World Gold Council)
As seen above, the proposed sale by IMF looks very insignificant to cause any meaningful change in the long term outlook of gold. This is obviously not something that needs to be factored into our assessment of the gold market`s prospects, provided that we are concerned with meaningful trends rather than short term gyrations caused by first reactions to any perceived negative news.
Even earlier, when IMF had announced its intention of gold sales it caused a similar knee jerk reaction and prices saw a decline for a very brief period. But, on RBI’s announcement of the purchase of 200 tonnes of the IMF gold, it led to a much larger upward reaction. Still, the possibility of the gold being purchased by central banks like China, India, Russia remains a high probability event and this time reactions to such announcements can lead to more bullish reactions than we saw after RBIs purchase. In addition, it could be argued that the more gold the official sector sells the less stable the monetary system and therefore, the more solidly underpinned the gold bull market becomes.
This correction in gold prices serves as an ideal opportunity to purchase gold from a long term perspective.
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The views expressed in this article are the personal views of the Fund Manager of Quantum Gold Fund. The views constitute only the opinions and do not constitute any guidelines or recommendation on any course of action to be followed by the reader. This information is meant for general reading purpose only and is not meant to serve as a professional guide/investment advice for the readers. This article has been prepared on the basis of publicly available information, internally developed data and other sources believed to be reliable. Readers are advised to seek independent professional advice and arrive at an informed investment decision before making any investments. Please visit – www.quantumamc.com/disclaimer to read scheme specific risk factors.
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