Gold 2012 outlook - short-term weakness, bullish in H2

Outlook for gold in 2012 is perhaps the most discussed topic in the global commodity markets currently. The precious metal has had a consistently glittering price performance in recent years. Having registered record highs in 2011, will the asset's price continue its golden run into 2012?

Interestingly, gold has entered the year with a slump in prices from the record highs reached in early September 2011 in US dollar terms and is currently trading in the vicinity of $1,650 an ounce. What direction would prices take from here? Will they slide to $1,350/oz or test $1,950/oz and in what timeframe?

Traditionally, gold has been known as a safe-haven asset and a hedge against inflation. In countries such as India, it also has mythological, historical, economic, social and cultural significance. Will emerging economies such as China and India continue to show appetite for gold as in the past? Will central banks continue to buy gold as asset diversifier?

At the moment gold is facing barriers to price gains. Primarily, there has been a preference for highly liquid assets given the financial market strains caused in the main by European sovereign debt crisis. The US dollar is strong while investors are feeling the need for liquidity.

Key factors

However, it is important to remember that two key factors have always catalysed the metal's price performance. One is the value of the US dollar and the other, real interest rates.

In the last several years, a falling US dollar pushed up gold prices in dollar terms. Especially since 2009, a rapid expansion in dollar as currency helped create an inflationary environment thereby generating demand for gold as a hedge against inflation.

Additionally, real interest rates have been falling and currently are at nearly zero. A potent combination of falling US dollar and falling real interest rates is what propelled the yellow metal to dizzy heights in the last three years or so.

There is widespread belief that the real interest rates are most unlikely to get any lower than they are today. So, without lower real interest rates, the US dollar would perhaps be the dominant or even the only factor that can potentially drive gold prices higher.

However, given the current global growth and currency market scenario including the unresolved European sovereign debt crisis and positive signs of growth emanating from the US, it seems highly unlikely that the dollar will substantially weaken in the short term or say in 3-6 months timeframe.

On the other hand, the weakness in the euro is likely to persist because a prudent solution is becoming increasingly intractable. The current level of speculative short positions on the euro at a record high on CME indicates the current market perception, experts point out.

Range-bound

So, with a firm dollar and little prospect of real interest rate falling, the short-term outlook for gold prices is range-bound movement, generally falling between $1600 and $1700 an ounce but with a $100 cushion on either side.

On the other hand, the medium-term outlook looks promising. Anything that triggers a dollar weakness should help gold rally. For instance, if the default risk on European bonds diminishes, the euro will gain strength and the dollar will weaken.

Because gold is a safe haven asset, continued uncertainty over global economic growth, geopolitical instabilities, concerns over long-term inflationary pressures and financial market worries can create a climate conducive for investors to flock back to the yellow metal.

In addition to investor appetite, central bank demand is another factor that can propel gold prices higher.

At what point in time gold will test $2,000/oz is difficult to tell at present; but what can be said with some confidence is that it may not happen until the middle of 2012. The metal's ride up is sure to be bumpy with rampant profit-taking along the way.

As for India, the rupee needs to be watched. The benefit of decline in dollar price of gold was neutralised by a rapidly weakening rupee which pushed domestic prices towards record highs and compressed physical demand.

The situation is unlikely to change anytime soon. In the domestic market, gold is likely to trade between a low of Rs 26,500 and a high of Rs 28,000 per 10 grams in the short run.

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