Thursday, October 8, 2009

>Gold's lure for investors makes it a riskier asset

London - The dominant role of investors in gold's rally to a record high this week raises the likelihood of a sharp correction in coming months before the metal rallies to higher prices next year, analysts said Wednesday.

Gold's rally to above USD1,000 a troy ounce has put it out of the reach of many jewelry buyers in gold-loving countries such as India and those in the Middle East. This leaves the market increasingly drifting free of its traditional anchor.

The latest move has been driven by speculators chasing prices higher. Should the dollar correct or inflationary signs prove elusive, a selloff could trigger a stampede for the exit with few buyers willing to take gold except at prices possibly 10% below today's, analysts said.

"If investment is taking over as a real driver of the market, then where does the support come from if investors do decide to pull out of the market for whatever reason," said Tom Kendall, a precious metals analyst at Mitsubishi Corp. in London.

UK-based metals consultancy GFMS in its annual survey last month forecast investment demand will account for 34% of world gold demand in 2009, up from 23% in 2008 and a stark contrast from the year gold began its long bull run in 2001.

In that year, investment demand was 364 metric tons, worth at the time $3.2 billion and a small share of total world demand. GFMS's forecast of 1,770 tons of investment demand in gold would be worth $51.6 billion at Wednesday's price of $1,042 an ounce.

The rapid proliferation of gold investment products catering to institutions, hedge funds and retail investors in the past four years has been responsible for this sea change by making it easier and cheaper for investors to get exposure directly to the gold price, rather than shares in gold-mining companies.

Gold exchange-traded products now have nearly 1,750 metric tons of gold under management, according to Barclays Capital, equivalent to about three quarters of annual world gold production.

Big name hedge fund managers like John Paulson at Paulson & Co. and Greenlight Capital's David Einhorn have captured the spotlight with their big bets on gold - Paulson at one point this year held nearly 9% of the world's biggest gold ETF, according to its regulatory filings - but pension funds and mutual funds have also gravitated to gold for its perceived status as a store of value.

"Ten years ago, there would have been very few funds that would have been active in gold," said Mitsubishi's Kendall. "Today even pension funds are active in gold."

The growing dominance of investors is making the market more volatile and deterring jewelry buyers, who have long been a steadying factor on prices.

Gold's reliance upon investor demand opens the market up to increased volatility, as short-term oriented investors are more likely to sell their positions during corrections, said Barclays Capital analyst Suki Copper, at a conference in London Wednesday.

According to the latest futures data for Comex gold futures, the net speculative long position stood at 28.8 million troy ounces, or 896 tons, and reached record highs in recent weeks.

Jewelry demand, meanwhile, fell by nearly a quarter in the first half to 760 tons, and is expected to fall by 20% for the year as whole, according to GFMS.

The metals consultancy estimates this will leave jewelry demand accounting for 44% of world demand in 2009, down from 70%-80% in recent years.

"[This] makes for a more volatile market," said GFMS chairman Philip Klapwijk. "It tends to lead to more pronounced swings in price because investors chase prices."

Klapwijk said jewelry's share of world demand could drop to a third over the next year, since there is little reason to think the U.S. will raise interest rates or support a strong dollar policy. A situation similar to gold's spike in 1980, when it rose to a record high, in current inflation-adjusted terms, of about $2,221 an ounce and jewelry demand was squeezed out of the market, could occur again as gold prices rise to record highs in 2010 before correcting sharply again.

"It's heading towards that type of extreme, and that type of extreme is nearing what's unsustainable," he said. "The problem is what happens when the music stops."