The Hindu Business Line : Views differ on gold’s response to sub-prime woes

Market signs
If gold emerges as a distinct standalone asset, its appeal as wealth preserver will be lifted.
Trade predicts prices will go up to $800 an ounce by year-end.
Stock market debacle pushed intl prices down by nearly $30 from around $670.

Gargi Shah

Mumbai, Aug. 29 Volatility in gold prices during the breakout of the US sub-prime mortgage issue has lead to the evolution of two schools of thought.

One school is of the view that continued slippage of the US economy as evidenced by events like the sub-prime mortgage losses would promote gold as a financial instrument – a safe haven investment in times of market uncertainty.

The yellow metal would be treated more as a currency than merely a commodity. Gold would thus be a beneficiary of the ongoing financial market turmoil and emerge as a ‘wealth preserver’.

Promoting this theory, Mr Paul Walker, CEO of GFMS explains that the recent fall in gold prices was the result of investors treating gold as a part of the commodities complex.

Bullish on price

If and when gold is decoupled from the commodities complex and emerges as a distinct standalone asset, the metal’s appeal as a wealth preserver would be lifted.

Gold would sit at $700 an ounce by this year-end, he says.

Sharing a similar sense, Mr James Turk, Founder and Chairman of GoldMoney, says gold prices would go up to $800 an ounce by the year-end and to $1000 an ounce by December 2008.

Despite the sub-prime issue leading to some liquidity crunch, Mr Turk is confident that the central banks would insert liquidity.

He explains that gold has no counter-party risk and deepening of the US credit problem is only positive for gold.

The second school of thought, although sharing the bullish sentiment, views the US sub-prime mortgage issue as a downside for gold prices.

In their view, a rising stock market sends out signal of a healthy economy.

Stock markets of both the developed and emerging markets have taken some serious beating since the outbreak of the US sub-prime issue.

Price decline

This time, however, the safe haven status associated with gold didn’t hold true. Gold prices in the international market declined by nearly $30 from around $670 in sync with the recent stock market debacle.

It could also have been the expectation that weakness in global equities portends weaker economies with reduced inflation. Generally, gold is sought as a hedge against inflation.

It may have been a shift in perceived safety from gold to the “full faith and credit” of the US, reasons Mr Tom Pawlicki, energy and precious metals analyst of MF Global.

Prices of gold can be between $700-730 an ounce by this year-end, said Mr Pawlicki adding that next year prices would remain flat.

Thus not gold but US treasuries and bonds would emerge as wealth preservers, he adds.

Also, observing the past behaviour one can argue that gold prices have moved in the zone where it has fallen along with the past debacles in the financial markets.

How will Fed move?

At present the trade fraternity are divided over the question of appeal of gold as a safe haven. But what remains is the commonplace bullishness in the yellow metal. What the fraternity is awaiting is the move taken by the Federal Reserve Board of the US.

In the event the Fed cuts interest rates by 25 basis points as expected by the market it will be an indication that the Fed has things under control, said Mr Turk. But a 50-basis points cut would send signals that the picture is more bitter than it seems, he said.

The jury is still out. Gold could be losing its sheen as a safe haven investment or a hedge against inflation. But the last word has not been said yet.

The market fundamentals are well balanced.

Stabilising fabrication demand; concerns over inflations due crude market, and unresolved geopolitical conditions are all bullish factors.

Sale of gold by European central bank and slowdown in de-hedging may counter this.

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