The Hindu Business Line : Gold downside risk at higher levels

The gold market has easily sailed through the $600-an-ounce mark and on its further upward journey is currently threatening to breach $700/oz. As the market increasingly moves away from demand-supply fundamentals and comes under increased influence of non-fundamental factors, caution is strongly suggested.

Belief is gaining ground that negative fundamentals and potential weakness on the investor front may make the yellow metal's move above $600 unsustainable for long.

HEDGING

Increase in mine production (4 per cent increase projected for 2006) and some new mines generating fresh project hedging can change the sentiment.

Although producers' attitude towards hedging remains not-so-friendly, many would opt for strategic hedging to take advantage of a greater contango and to lock-in the current high price levels.

Demand compression is another factor. High prices have resulted in increased scrap sales. Jewellery demand has considerably slowed down, especially in price- sensitive market such as India as well as China, West Asia and Turkey.

FUNDS FLOW

Given these developments, for gold prices to remain at high levels, there is greater dependence on increased flow of speculative funds. No doubt, rising energy prices raise inflation concerns; but to what extent it feeds through the economy to actually result in inflation remains to be seen.

Similarly, gold's safe haven status may come under pressure, should concerns relating to Iran's nuclear ambitions get resolved. However, it must be conceded, it is probable that some of the seemingly intractable issues like Iran may continue to influence the market.

So, what is important to monitor when correction starts to occur.

Speculators would be the first to liquidate their position and strategic investors may follow suit and exit. The non-commercial long positions have to be monitored closely. So, for investors, it would be instructive to keep their eyes and ears open to read market signals.