Has Gold Price Topped?

by Anthony Dass

To answer this question, it is essential to get back to history. Gold was always money until 1971 when US President Richard Nixon and the International Monetary Fund decided it would no longer be so. This decision worked well because oil was firmly linked to the US dollar and vice versa. It allowed the US to dominate the oil producers who were dependent on the country for their security.

With the support of the entire developed world, the US dollar stood completely un-backed and entirely reliant on the wisdom of the US Treasury and the US Federal Reserve (Fed) for its reputation. Soon, other currencies grew to depend on US dollar for their acceptance in the global monetary system. The US dollar reigned as money, while gold was sidelined to a mere metal.

The US took the opportunity and allowed a persistent trade deficit to occur over decades. It meant that the US will print new US dollar to pay for imports. No real exchange was needed to cover the deficit. And so, foreign governments including oil producers, filled their coffers with promises of payment by the US government in the form of US dollars.

Moving into the new millennium, the gold prices witnessed a long and mostly continuous rise, from an average of US$272.25 an ounce in 2000 to reach an average of US$1,668.7 an ounce in 2012, which translates into a gain of 512.4%, a sharp contrast to the previous decades. A number of factors influenced the gold prices. Among them were:

1. Drop in gold supply: The 1999 agreement entitled the ‘Washington Agreement’ limited the sale of the amount of gold;

2. Concern over the US national debt and the weakening US dollar: Since the beginning of 2000s, the outlook of US national debt and the weakening of the US dollar relative to other currencies flared. Fears are whether there will be a US dollar crisis;

3. Stronger demand from India and China: Increase in demand for gold from India, the world largest market for gold jewellery, driven by wedding, festive season and hedging against the inflation risk. Also, China is now the fastest-growing market for gold jewellery namely jewellery fabrication;

4. Eruption of the credit crunch in the US in 2007 led to a global financial crisis in 2008, which resulted to:

• Reputation of the US dollar and euro to plummet;
• Prices of gold and other commodities being quoted in other currencies as well as the US dollar;
• China seek to see the yuan become a global currency – indeed a reserve currency; and
• Surplus nations were reducing the vulnerability of their reserves to a fall in the exchange rate value of the US dollar against their currencies as well as against other currencies.

5. Other factors: Central banks stepping-up their gold reserves at the end of the decade, while the 2008 global crisis that led to US nationalising two of the biggest US mortgage lenders and biggest insurer, fuelled demand for physical gold and exchange traded funds.

Turning to 2013, we have witnessed a free fall in gold prices, raising the eyebrows of many. The free fall started on April 11, 2013, falling from US$1,516.5 an ounce to US$1,376.58 an ounce on April 16, 2013, down by 11.8% and 18.7% drop from 2013’s peak. The sharp drop in gold prices could be due to the ‘herd behaviour’ driven by:

1. Below expectation Chinese real gross domestic product in first quarter of 2013 of 7.7% year-on-year, suggesting the world's second biggest gold consumer and the second largest oil consumer would weigh on potential demand for gold;

2. Fear that some of the troubled euro nations like Cyprus may sell some of their reserves to beef up its own contribution to the bailout by international lenders, and other troubled euro countries like Italy and Spain may follow suit;

3. Concern that the Fed may end the easing monetary policy sooner after unveiling more positive economic data; and

4. Rising US corporate earnings result in rising stock values may see investors switch to equities rather than gold.

Irrespective of the recent free fall, we felt that the ‘golden era’ is coming to an end in 2013, with more downside risk to gold prices than upside gains. While we expect the euro-risk to continue in 2013, the outlook for the US is posed to improve, implying possibilities for the Fed to end the quantitative easing programme in the second half of this year or early 2014. Equally important, for gold prices to increase in 2013, it needs strong conviction to hold more gold. This is something that is waning despite the resurgence in euro-area risk aversion and some disappointment to the US economic data of late.

But the decline in gold prices is unlikely to be overly exaggerated in 2013 and 2014. A slow trend reversal is expected due to: (1) central banks will still be in force, especially the Chinese and Russian banks who are likely to seize this opportunity of low prices to make their balance sheets become more independent from the US dollar; (2) slight pick-up in jewellery demand by India who make up about 29% of world jewellery demand, and the fast-growing Chinese market, accounting for about 26% of world jewellery demand; (3) healthy investment sector, especially since investors prefer physical gold than ‘paper gold’; (4) modest pick-up in demand from technology; and (5) slight increase in supply of gold.

We expect gold price to average US$1,600 and US$1,500 an ounce in 2013 and 2014 respectively. Softer price is because despite resurgence in euro-area risk aversion, some disappointment to the US data and pricing-in geopolitical risk, the average gold prices have been weak since January this year, suggesting lack of ‘conviction’ to hold gold is increasing.

Anthony Dass is chief economist at MIDF Amanah Investment Bank Bhd.