The Hindu Business Line : Market has room for upside in yellow metal

Price movement
With huge funds chasing gold, the prices may rise.
Gold prices are not guided by market fundamentals.
The prices may fall during the correction phase.

Mumbai , May 25

If any further evidence of gold prices moving away from what may be justified by market fundamentals was needed, the latest report from GFMS Ltd provides it.

The gold market was in sizeable surplus of 196 tonnes in the first quarter of this year. This was excluding producer de-hedging (which is mainly on paper). Even after including de-hedging, the market was in a surplus of 36 tonnes.

scrap sales

Mine supply growth (up five per cent year-on-year) and old scrap sales (up 51 per cent) countered slower official sector sales that fell by 57 per cent.

Total demand fell by around 16 per cent year-on-year.

This decline in demand translates to a still large 11 per cent loss when placed against last quarter of 2005, when the surge in price strength and volatility already had an adverse impact on demand.

According to analysts, this should come as little surprise since around 77 per cent of total physical gold demand is made up of price-sensitive jewellery demand, which itself fell by 22 per cent year-on-year and by 21 per cent quarter-on-quarter.

Interestingly though, in India, despite a sharp decline in jewellery demand (38 per cent fall year-on-year to 103 tonnes), retail investment demand rose by 32 per cent year-on-year to 42 tonnes, possibly reflecting more awareness of gold as an investment asset together with rising prices.

Rising prices

Aggrieved by rising prices, recently, some parliamentarians reportedly approached the Government seeking some restrictive measures against the yellow metal. It may be instructive to mention that Indian prices merely reflect international prices.

Because demand for gold is highly price elastic in the country, domestic physical demand growth has slowed down considerably. Indeed, scrap sales are rising. On the other hand, investors in the domestic market buy gold on the exchanges with the hope of booking profit when prices rise. Domestic players have no impact on the global gold market.

Sharp corrections

The massive inventory overhang suggests that there is seldom a direct link between gold's physical market and prices, while the lack of strong fundamentals points to more vulnerability to sharp corrections compared with some other commodities such as copper, according to Barclays Capital.

This has served to highlight the dominance of speculators in driving gold prices as several non-fundamental risks including uncertainty over the dollar, rising inflationary threat and geopolitical tensions have created conducive atmosphere to be positive on gold.

Despite not being justified by demand-supply fundamentals, with huge funds still flowing towards the yellow metal, the market has room on the upside. This also implies that price could fall rather sharply during the correction phase.