Gold near $1600/ounce

Gold had a dramatic rally since the start of 2001 and picked up well from 2008 onwards. Currently prices are quoting at a fresh historic high- just few dollars below the $1600 mark.

Gold is generally regarded as a safe haven and when any uncertainty arises in the global economy, it becomes favorite among investors, fund managers and for general people.

It is seen that official sector is also adding gold in their reserve for diversification of portfolio due to uncertain outlook on currencies.

As per data available Mexico, Russia and Thailand added gold valued almost $6 billion to their reserves in February and March during 2011.

The paper gold sector which is known as “Gold ETF” has also seen surge in demand as a safe investment.

SPDR Gold Trust, the biggest exchange-traded fund backed by bullion is now holding a huge chuck of Gold reserves which is larger than official holding by the central bank of Switzerland, China, Japan, India, and United Kingdom. There has been slight long liquidation recently but holdings are still large showing investors expectation of gold price.

You must have seen in newspapers about rising forecast by big investment houses, banks and even brokerage house. Market participants are now expecting Gold prices to test $2000 an ounce in next one to two years time frame

What is causing sharp rally again in Gold prices after recession

Gold prices run up since 2008 is mostly driven by investment demand.

Rising concerns on government debt, inflationary trend, uneven trend in foreign exchange rates, expectation of further easing by Central banks, slowing down of global growth- all are leading safe haven buying in Gold.

Debt concerns in the EU region and US

From late 2009, fears of a sovereign debt crisis developed among investors concerning PIIGS (Portugal, Ireland, Italy, Greece and Spain) nations in the EU area.

In 2010 the debt crisis was mostly centered on events in Greece, where the cost of financing government debt was rising. On 2 May 2010, the euro zone countries and the International Monetary Fund agreed to a €110 billion loan for Greece, conditional on the implementation of harsh austerity measures. The Greek bail-out was followed by a €85 billion rescue package for Ireland in November and a €78 billion bail-out for Portugal in May 2011.

In May 2011, the crisis resurfaced, concerning mostly the refinancing of Greek public debts. The problems have been compounded by political instability in Greece.

In late June 2011, it was brought under control with the Greek government managed to pass new austerity bill and EU leaders pledging funds to support the country.

Concern about rising government deficits and debt/GDP ratio has led a wave of downgrading of European government sovereign rating.

Debt Status of PIIGS Nation

Country	S&P	Moody	Fitch	Debt as %GDP
Greece	NEG	NEG	--	144
Portugal	NEG	NEG	--	83.2
Ireland	STABLE	NEG	NEG	94.2
Spain	NEG	NEG	NEG	63.4
Italy	NEG	--	STABLE	118.1

Recently, Italy and Spain two largest economies in the EU area has seen rise in sovereign yields towards risk level causing panic in markets.

Spain and Italy 10 yr bond yields shoot to 6.4% and almost 6% respectively.

However, yields remain well below the 7% threshold that served as death knells for the ability of governments to tap credit markets to meet funding needs in these two countries. Spain and Italy are too big to be bailed out by the European Union.

Ireland and Portugal all sought international assistance after their 10-year yields rose past 7%.

Italy has more than 500 billion euros of bonds maturing in the next three years. That’s about twice as much as the 256 billion euros extended to Greece, Ireland and Portugal in their three-year aid programs.

County	Real GDP YoY	Unemp. Rate	CPI Yoy	Indus Prod YoY	Retail Sales YoY	Consumer Confidence
Greece	-5.5	16.2	3.3	-10	-4.8	-75
Portugal	-0.6	12.4	3.8	-0.3	-7.9	-50.7
Ireland	0.1	14.2	2.7	-5.4	-2.1	56.3
Spain	0.8	20.9	3.2	0.8	-1.4	74.9
Italy	1	8.1	2.7	1.8	2.52	105.8
EU	2.5	9.9	2.7	5.3	-1.9	-9.8

 The crisis may deepen further if any Italy and Spain yield reaches risk level. Looking at the recent GDP figures from PIIGS, their economic outlook looks weak.

Austerity measures taken by these countries are expected to dampen their long term growth.

Another factor that is concerning is the US public debt ceiling. Moody's Investors Service placed its Aaa rating on U.S. government debt on review for a possible downgrade within three months. They argued that they had taken their decision “given the rising possibility that the statutory debt limit will not be raised on a timely basis, leading to a default on US Treasury debt obligations.

On June 2, Moody's warned that a rating review would be likely in mid-July unless there was "meaningful progress" to raise the debt limit.

 In mid-April, Standard & Poor's lowered its outlook on the government's triple-A rating from stable to negative. That meant S&P thinks there is a 1-in-3 chance the rating could be cut within two years.

President Barack Obama and top Republicans face growing pressure over how to avoid a U.S. debt default as an Aug. 2 which the deadline for rising limit. Ben Bernanke- the Federal Reserve Bank Chairman said that if the debt limit is not raised in time, the United States would pay its bondholders first. That would mean other payments, such as Social Security to the elderly, would be the first hit

Slowing Down of global growth since 1^st Quarter 2011 along with rising prices towards pre crisis level

The global economic recovery has been fragile after recession and seems mostly monetary and fiscal stimulus driven. Developed economies such as the US and Europe are still maintaining low rate of interest as the recovery has not been strong. The Fed chairman said that the growth in the US has been frustratingly slow, citing his concern. The world economy is now at a crucial stage and any further consolidation in the 2H may put pressure on policy makers.  The graph below shows the slowing down of manufacturing and services in the developed market. 

In the US, the most known Weekly Leading Index (WLI) Growth indicator of the Economic Cycle Research Institute (ECRI) declined to 2.0 during the last week of June making it 10 consecutive weeks of decline from the 11-month interim high of 7.8 for the week ending on April 15. A significant decline in the WLI has been a leading indicator for six of the seven recessions since the 1960s.

 Despite growth slowing down, price rise have not moderated. Inflation across nations ex Japan is now heading towards their pre-crisis level. The recent data shows Asia's economy continues to slow due to tightening policy and staggering growth in the US & Europe. Comments from Asian central bankers suggest tighter policy will remain a near-term priority despite growth is slowing down

Inflation pressures have prompted most Asian central banks to be among the quickest to withdraw monetary stimulus as growth gather speed following the global recession in 2009. India, South Korea, Thailand and Taiwan raised their benchmark interest rates further to contain rising prices, while China raised banks cash reserve requirements.

Apart from emerging nations, inflation in the EU, US and UK are above the target rate set by their central banks

Investors believe Gold as a pure inflation hedge and it has been rendering support to prices.

Room for QE 3^rd in the US if growth slows- one major factor for rising commodity prices

Last November, the Fed announced that they would buy an additional $600 billion of long term treasuries ($75 billion each month) pumping liquidity in the market and keeping the market rate of interest at lower levels.These purchases have been completed by the end of June and now with string of weak economic data’s market are betting for QE 3^rd which may again push up commodity and precious metals prices higher.

Ultra-loose monetary conditions are particularly helpful for commodity prices because they minimize the opportunity cost of holding assets that do not pay any interest, while increasing demand for hedges against inflation.

The QE2nd was based on twin objective- brining down unemployment rate and risk of deflation.As of now there is no deflation risk and inflation is above 3.0%, but unemployment rate is still at higher levels. There has been a short term positive relationship between interest rate and unemployment rate. But, fed easing failed to bring down unemployment to comfortable level due to structural issues.

However, economic growth slows then we may see another round of easing of easing and this will be highly accommodative for Gold prices and negative for US currency.

Gold Prices in US dollar and Euro terms

Gold Prices and Fund Position at COMEX

Gold is now expected to stay costly and further rise in prices is most likely as a global economic concern deepens. We may see further financial assistance in the EU region and also sovereign default by small countries such as Greece, Ireland and Portugal. US sovereign rating cut is a likely scenario and there is also a possibility of QE 3^rd in days to come. In such a scenario gold reaching further high such as $1700-$1750 is not a big deal. We believe investment demand to continue to drive gold prices higher in H2 2011.

Data Sources- Reuters and Bloomberg