|Chart 1: Gold Price Vaulted In
|Chart 2: The Comparison of Gold Rally
|Chart 3: Breakdown Of Gold Demand
|Chart 4: Gold Equities Are Still
Trading At Discount
- In the recent rally, gold price has been
moving in tandem with the US dollar, indicating the overwhelming demand
for the safe haven assets is the primarily factor that drives the gold
price upwards this time.
- The return during end-March to 12 May 2010
is lower than the previous rally, even though gold price hit a new
- Currently, the downside risk for gold price
is similar to the crude oil price in July 2008.
- The expected return of gold is lower than
the expected returns of our favourite markets
- We continue to recommend investors to avoid
funds with exposure to the gold futures.
- We stay neutral in the gold equity.
Gold spot price hit a record high of US$ 1235
per ounce on 12 May 2010 as the sovereign debts woes in Europe spurs
risk aversion. Investors remain concerned about the details of the 750
billion euro rescue plan and the externalities of the liquidity
injection to the European economy. Gold, as a safe haven and a good
hedge against inflation, climbs sharply in a flight to safety.
Traditionally, the gold spot price is inversely
correlated with the US dollar. In the recent rally, however, gold price
has been moving in tandem with the US dollar. It indicates the
overwhelming demand for the safe haven assets is the primarily factor
that drives the gold price upwards this time.
Gold Price Vaulted In
Chart 1 shows the performance of gold price
since 2010. In the first quarter of 2010, gold spot price increased by
only 1.4%, lower than the MSCI Emerging Market and MSCI World Index. It
was also underperformed by the average returns of the markets under our
coverage in the same period. Gold price was mainly traded in the range
of US$1085 to US$1140 in the first quarter. This supported our view
gold price will remain vulnerable as indicated by the sluggish
1-year forward price.
|Table 1: Timeline of the
Europe’s Debt Crisis (Reference of Chart 1)
1. 24 March 2010
|Fitch Ratings lowers
sovereign credit rating by one notch to AA- and warns of further cuts
2. 6 April 2010
|10-year Greek government bond
jump to 7.1%
3. 9 April 2010
|Fitch cuts Greece’s
credit rating by two notches to the lowest investment grade rating BBB-
4. 22 April 2010
government bond rating to A3 from A2
5. 5 May 2010
|The euro tumbles to a
against the dollar
6. 10 May 2010
|EU officials agree to 750
rescue plan to support the debt-laden euro zone countries
|Source: Wall Street Journal
and iFAST compilations
From end-March 2009 till 12 May 2010, as
Europe’s debt crisis worsened ominously following a series of bad
news (see chart 1 and table 1), gold spot price surged 9.8%. For
example, after the 750 billion euro rescue package was announced, the
gold price surged 2.5% in the following trading day (11 May) as
investors worried about the inflation risk in euro zone economies and
the devaluation risk of euro.
Notably, the recent gold rally is comparable
with the spike in November 2009 (see chart 2). From 1 November to 2
December 2009, gold price jumped 14.8%, breaking away from their
sluggish performance in the past 6 months. A double-digit increase in
gold price for a single month is quite unusual. We believe speculation
was the dominant force that spurred gold price (see Gold
Bubble Set To Burst In 2010). On the other hand, the
end-March to 12 May 2010 is lower than the previous rally, even though
gold price hit a new all-time high. It implies that investors are more
cautious about the high gold price in spite of spiralling contagion
fears on Europe’s debt crisis.
Similar To Downside Risk For
Oil Price In July 2008
Currently, the downside risk for gold price is
similar to the crude oil price in July 2008. From February to July
2008, oil price rose from US$ 88 per barrel to a peak level of US$ 145
per barrel, delivering a 63% gain. At that point in time, some
“peak oil” experts predicted that oil price will hit US$
500 per barrel because of the robust demand from emerging markets.
Since then, oil price plunged significantly and fell below US$ 33 per
barrel in December 2008. The Commodity Futures Trading Commission put
the blame on the speculators for their significant role in driving wild
swings in oil prices.
Similarly, the upside momentum of gold price
has no support from the fundamentals. The gold rally has been strong
and comparable with the crude oil price. Since May 2010, the gold price
hit a fresh record high and the momentum is also as strong as the rally
price. Investors should be more cautious about the potential downside
risk of gold price.
Demand in jewellery, which consistently
accounts for over 60% of the total gold demand, is still very sluggish
as shown in chart 3. Jewellery consumption plunged 20% year-on-year in
2009 and 8% year-on-year in the fourth quarter of 2009 (measured by
tonnes). On a quarter-on-quarter basis, a strongest growth should be
recorded in the fourth quarter traditionally due to Diwali, Christmas
and other year-end festivals, but in the fourth quarter of 2009, demand
has only picked up by a mere 2.4%.
On the other hand, ETF demand rose 85%
year-on-year in 2009 to 594.7 tonnes. The strong demand in 2009 was
largely driven by an exceptional result in first quarter which soared
to 465.1 tonnes. Demand in the fourth quarter of 2009 was significantly
lower than the demand in both year-on-year or quarter-on-quarter bases,
as well as the average quarterly demand over the past 5 years.
In the article Gold
Bubble Set To Burst In 2010,
we have mentioned that economic growth is a leading indicator of
jewellery demand and will head the demand for the next 2 to 3 quarters.
As the global economy has just started to recover, it may take more
time to see demand for real physical gold to pick up.
Ultra Low Interest Rate
Up the Gold Price
Investors fret that the aggressive fiscal
austerity measures in the euro zone countries will slowdown the region
economic growth. Uncertainty in Europe will postpone the major central
banks’ rate hike timetable. As a result, a massive amount of
speculative capital has entered into the markets. The gold holdings of
the world’s largest gold-backed ETF, the SPDR Gold Trust,
remained flattish in the first four months this year. the holdings was
increased significantly by 50 tonnes or 4%, to a record high of 1209
tonnes from 1 to 12 May 2010.
Investors should note that gold investment does
not generate interest. If the Federal Reserve starts to raise interest
rates, investors will re-embrace the US dollar and there will be a
re-pricing on gold. The gold price would then experience a nasty
More importantly, the upside potential for gold
price is limited after the rally. The expected return of gold is just
13% (as at 14 May 2010) given that it can hit the target price of US$
1400/ounce which is the most bullish call in the Bloomberg survey (the
mean estimate is US$1180). This is lower than the expected returns of
our favourite markets like Russia, Korea, China and Hong Kong.
|Table 2: The Expected
Returns of Our Favourite Markets In 2010 (As At 14 May 2010)
Hong Kong (Hang Seng Index)
Russia (RTSI Index)
|1400 (Target Price)*
|Source: Bloomberg and iFAST
*Most Bullish Forecast in Bloomberg Survey. The Market Consensus is
US$1180 in 4Q 10.
We stay neutral in the gold equity. On
hand, we expect the analysts to revise the estimated earnings of gold
mining companies downward once the gold price drops. On the other hand,
the gold mining companies continue to benefit from the rise in the gold
price. Also, as shown in chart 4, gold equities are still trading at a
discount to its long-term trend (gold equities still fall beneath the
linear trend in recent months). Thus, we remain neutral for the gold
Bubble Set To Burst In 2010
Research Team is a part
of iFAST Financial India Pvt Ltd.