Analysis: Financial storm clouds set gold on course for history

By Jan Harvey and Veronica Brown

LONDON (BestGrowthStock) – An ill wind blowing through financial markets is breathing vigor into gold, which could mark record highs for the third time this year in September — or sooner — as fundamental and technical factors align.

A spate of unimpressive economic data from the United States has raised expectations the world’s biggest economy will keep interest rates low for an extended period, and may have to extend its quantitative easing program to buoy growth.

Meanwhile a fresh ratings downgrade of Ireland has shown worries over the euro zone’s fiscal health are far from over.

“Gold is at a fantastic point right now,” said Ashok Shah, chief investment officer at London & Capital. “All kinds of indicators are showing that things are gradually slowing down.”

“That increases the prospect of more quantitive easing,” he said. “In essence, that’s great for gold.”

Gold has hit records twice already in 2010, scoring its current peak of $1,264.90 in June as the euro zone sovereign debt crisis sparked flights to safety. Investors worried that monetary loosening would ultimately prove inflationary.

The inflation story has so far been treated with caution, as with the more immediate focus on deflation. But if economic growth stalls, that may change.

“Should we see further deterioration and another round of significant stimulus, inflation will sneak closer to the front of investors’ minds and that would be positive for the gold story,” said RBS analyst Daniel Major.

“Should we see a meltdown in economic data stimulating significant safe haven inflows and gold breaks above its recent highs we could see significant further gains,” he added.

The metal’s latest swing higher after a retracement in June and July has improved its technical picture. Commerzbank analyst Axel Rudolph said gold’s bounce off this week’s low at $1,210 was positive, with $1,250 targeted before the June high. Barclays Capital projects $1,350 and higher later this year.

Spot gold is currently near 8-week highs of $1,244 an ounce. Significantly, gold is also rising in non-dollar terms.

Euro-priced gold, which hit an all-time high above 1,050 euros an ounce in June, rose back above 980 euros again this week for the first time since July 1. Sterling-priced gold has also risen back above 800 pounds an ounce.

“It’s really on the crosses where you want to see (gold) performing,” said Simon Weeks, head of precious metals at the Bank of Nova Scotia. “I would definitely expect new highs.”

OPTIMISM EMERGES

This rally has the benefit of coming at a time when more optimism is emerging about the jewelry market, which has come under heavy pressure in recent years from high prices.

According to the World Gold Council, global jewelry demand in the first half of 2010 was 16 percent higher than the same period of 2009 despite a 24 percent rise in U.S. dollar prices.

“Jewelry consumers have become accustomed to the higher price,” said the WGC’s Eily Ong.

Indian buying usually rises during the festive season, which began this week with Raksha Bandhan and runs until Dhanteras in November, the biggest gold-buying day in the festival calendar.

Demand from China is also set to rise as the country moves toward liberalizing its gold market. China is the world’s second-largest gold consumer, but as it is also the world’s biggest miner, much of its trade has historically been domestic.

However, demand is so great that it can outstrip domestic output by 100 tons a year.

Supply is limited. While miners are likely to try and raise output to capitalize on rising prices, this will be slow.

Selling by central banks has tailed off sharply in recent years as gold’s appeal as a reserve asset increases, while scrap gold supply has failed to match the peaks of early 2009.

INVESTMENT KEY

But while tight supply and a return of physical demand is set to add further fuel to gold’s rally, it is investment that will provide the real swing factor for gold.

Funds favored the metal in the second quarter. Hedge fund Paulson & Co kept its stake in the largest gold exchange-traded fund the SPDR Gold Trust, and now has a 7.4 percent holding in the trust, while billionaire George Soros also held onto the bulk of his stake while cutting exposure to equities.

“If you look at global asset allocation, the allocation into gold is still very small, less than 1 percent,” WGC’s Ong said. “Given gold’s recent strong performance, there should be huge potential for (that) to rise.”

That will largely be dependent on gold’s performance against other asset classes — and that in turn will be reliant on the global economic climate.

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For a graphic showing gold’s relative performance against other commodities, click: http://r.reuters.com/hun72k

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“Since the whole financial crisis broke out…, gold’s correlation with the industrials is pretty much zero. It’s now an anti-commodity,” said Sean Corrigan, chief investment strategist at Diapason Commodities Management.

“Do we continue to have worries on financial markets themselves like banking and sovereign risk? Do we have the continued drum beat of disappointing economic data? If that is the case, gold will do better than anything else.”

(Additional reporting by Amanda Cooper in London and Frank Tang in New York; Editing by Sue Thomas)

Analysis: Financial storm clouds set gold on course for history