The Hindu Business Line : Falling gold prices may spur physical demand

Mumbai, Aug 7 Recent easing of gold prices following decline in crude and sell off in base metals has ignited greater interest about the future price movements of the yellow metal.

Concerns in the broader financial markets, slowing global growth and decelerating physical demand have also impacted the commodity. However, gold continues to be a popular asset as a safe haven investment and hedge against inflation.

Are the current levels (around $880 an ounce) good to buy at? Will the gold market spike upwards of $950 and possibly breach the psychological $1,000 an ounce? Major producers continue to remain upbeat about the price prospects and major consultancies have not ruled out four-digit prices. Investor interest is obviously going to be the key. To attract investment, there has to be strong expectation that the yellow metal will outperform other assets and classes of assets.

Prices to decline

There are varying forecasts about the future of gold; but the slowly gathering overall expectation is that gold prices are set to decline over the next 12-18 months due to currency factors, improvements in other financial markets (especially equity) and waning inflationary fears. No wonder, the US commodity market regulator CFTCs latest weekly Commitment of Traders report showed that speculators (called non-commercials) reduced their long positions in gold (futures) in the week ended July 29.

Speculators have had a sizeably long position and even after some exited the market, there is still notable amount of net long position. Research done by Commonwealth Bank of Australia suggests that gold prices will remain volatile at a high level over the balance of the September quarter; the end-September price forecast has been moderated though. We believe that the gold price will step lower over the latter part of 2008 and in 2009.

Investor interest in gold is expected to wane over this period as the US dollar retains a firm tone. Not surprisingly, physical demand for gold in the jewellery sector has been tepid because of high prices and volatile market conditions. Once prices trend lower from even the current levels, demand may pick up and provide support.

Low demand

A key market for gold, India, is currently going through uncertain times in terms of overall economic performance and agricultural production. High and volatile prices have no doubt dented Indian demand in the last few months. Going forward, crop conditions are less-than-satisfactory and inflation remains unabated.

A weaker rupee has added to the cost and largely neutralised the recent decline in overseas market. Gold prices have to decline substantially more to be able to generate genuine consumer demand. It may happen sometime next year.

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