We live in uncertain financial times. The problems are serious and growing, the solutions are limited. It’s as if everything that could go wrong, has gone wrong with financial and economic headwinds having converged to interrupt world growth. There is a worldwide flight into assets of quality. It is easy to see why the safety of one’s financial assets is suddenly all-important. It is estimated that already more than $10 trillion ($10,000 billion) of value has been lost in the world market decline so far. The scale and scope of the destruction of asset values and offsetting financial injections are almost beyond our ability to grasp.

Backdrop

Gold and silver have been trusted assets in times of distrust. Silver (and gold) may go up or down, but they can’t defraud you. When fear and emotion run high, it often creates exceptional profit opportunities. Additionally, a large amount of the world’s gold inventory resides in government hands. While there appears to be a lull in Central bank gold sales, higher prices and budget pinches may induce more official gold selling in the future. In gold, two billion ounces exist in world bullion inventories, and less than 50 million ounces, or less than 2.5%, are held in publicly-owned entities. The spot gold price on the last trading day of 2008 closed higher than the closing gold price on the last trading day of 2007, reinforcing the pattern of continuous year-to-year closing on strength. The pattern of the year end closing gold price being higher than the previous year’s closing gold price has been maintained since the year 2000. The closing price for gold bullion in 2008 was $880.30. This maintained a nine-year sequence of a higher year-over-year closing price. This once again portends 2009 as a strong year for gold and a continuing higher year over year closing price.

Global gold production is falling despite the relatively high gold prices. Annual gold mined today, which is 70% of the world’s supply, is running over 4% lower than when this bull began in 2001. Global reserves are also shrinking, despite vast sums being spent on exploration. With mined gold supply heavily constrained despite the best efforts of the world’s elite miners and the strong gold-price incentives to produce, any demand growth cannot be satiated with mined gold. And even if gold mining somehow becomes easier (geopolitics are less hostile, for example), it will still take the better part of a decade before new supplies can be brought online. This is incredibly bullish for gold.

Global snapshot

Since 2001, we saw world GDP grow at the fastest pace since WWII, doubling to $55 trillion. Fundamentally, industrialization of Asia and Middle-east spurred growth and vast commodity consumption. On the investment side, dollar savers of 20 years came to the realisation that dollars are no better than Brazil Real (literally based on currency performance) and started the massive flight from dollars. This dollar diversification coupled with low interest rates further fuelled commodity, real estate, and equity markets worldwide. All this is at the expense of the dollar, which lost some 60% measured by the dollar index.

Gold predictably went up 300% from $250/oz to over $800/oz. 2008 is a hiccup to the above trend. Housing implosion bankrupted US banks and caused temporary hard squeeze on the dollar. Fed Chairman Ben Bernanke and US President Barack Obama have promised to take whatever fiscal and monetary action necessary to revive the economy. All this seals the death fate of the US dollar and will likely invoke imminent panic from dollar holders. Growth in Asia and elsewhere in the world will not stop just because no more dollars are coming from the US consumers.

The dollar

The US is the world’s largest economy by far and the dollar is the most liquid currency and de-facto settlement currency for global trades. As we go through the deleveraging process, dollars will continue to be raised for debt repayment. Comparatively speaking, currencies that make up the dollar index basket are in no better shape. The US budget deficit is forecasted at $1.8 trillion for the year 2009, well over 13% of GDP for the foreseeable future. This is likely to put a strain on the dollar. There are also record amount of dollars abroad yet to be diversified and spent. The factors that are driving up the dollar are temporary; therefore a dollar correction could be underway soon with the dollar index between 94 and 72 for 2009. Recently, gold had been moving in tandem with US dollar movement, as both are driven by risk aversion among market participants.

Crude & gold

Crude prices were a supportive factor responsible for the sharp rally in gold prices in 2008 as substantial inflationary pressures were built across the globe as crude hit a record high of $147.27 on July 11, 2008. Since then, prices corrected sharp, hitting multi-year lows to touch a low of $33. It has been observed that crude and gold prices are positively correlated as gold being a hedge against inflation. Currently, crude prices are trading down as global economy continues to remain extremely bearish, which in turn is pulling down crude demand. Overall, lower crude prices exert downward pressure on gold prices.

Outlook

Gold has been the best performing asset class of the decade and now that the global financial meltdown shows no signs of a slowdown, investors are hard pressed to find any investment that has performed well over the last ten years as consistently as gold. Also, gold has been generating an average of 10-17% returns per annum, which is sufficient enough to witness fresh funds flow into the bullion market. The US, UK and Europe and other developed and emerging countries are similarly, and in some instances co-operatively, using monetary policy and fiscal stimulus packages to try to stave off a deeper global recession. The impact of these packages is, however, unlikely to be felt substantially before late 2009, at the earliest.

Global financial markets are expected to take longer time than earlier expected to stabilize, with the IMF recently projecting a contraction in global growth by 1.30% in 2009. This brings forth the important point that though global equities markets have revived in the past couple of months, the real economic situation, primarily in the US, Euro-Zone and Japan, still continue to remain grim. The unemployment levels in the US currently hover around 8.70%, which is expected to touch double digits in the coming months. Further, Euro-Zone is also struggling very hard with the unemployment rate expected to rise to 11% in the near future. On the positive side, it is expected that Asian economies such as India and China would manage better given their vibrant domestic markets and relatively less exposure on the US credit markets. Of late, better-than-expected US economic data, increasing consumer confidence and slight pickup in housing market in the US, better-than-expected stress tests results of the US banking sector, are positive cues. But still it is too early to assume that things are going to be normal anytime soon.

It is no wonder that gold is the most favoured commodity in most 2009 forecasts, as we see it benefiting from financial market troubles and rush towards safe haven investing. Also, the increasing money supply on the back of trillions of dollars being injected into the global financial system will have an inflationary impact that bodes well for gold, as it is considered as a hedge against inflation.

Factors of the ETF and jewellery/fabrication demand, the direction of the global equities markets, the movements in the dollar against other major currencies and finally, the rupee movement, would play a very important role in impacting gold prices.

Gold continues to remain bullish with key support levels seen at $860/$820 (per troy ounce) and key resistance levels seen at $965/$990 (per troy ounce). The overall long-term trend remains up. On MCX, prices shall find major supports at Rs 14,080/Rs 13,200 (per 10 grams), whereas on the upside, resistances are seen at Rs 15,200/Rs 15,870 (per 10 grams) respectively. Trading decisively above $990 levels in Spot Gold would lead to new highs in gold in 2009.

The author is associate director (commodities and currency) Angel Commodities