Friday, October 21, 2011

>GOLD: Macro and financial factors driving gold returns over the past three years should remain in place for 2012.

Goose with the Golden Eggs

 Gold holds a unique historical status as a non-consumable commodity universally
recognized as a medium-of-exchange. Given the large amount of non-perishable
inventory overhang, traditional demand-and-supply dynamics do not apply in the short
term. In times of macroeconomic stress, financial factors may drive gold prices well
above physical costs of replacement for extended periods of time, thus exhibiting
“bubble-like” characteristics.

 There is a high probability that macroeconomic and financial factors which have
propelled gold prices over the last three years will continue for the next 12 to 18
months. We look at three major macro-financial drivers of nominal and real gold price
returns: denomination effects from inflation and currency adjustments, followed by real
interest rates, and finally financial demand for gold as a safe haven.

Denomination — Nominal gold prices quoted against the US dollar must reflect
changes in the value of the denominator. Common measures of changes in the
purchasing power of the US dollar include consumer price inflation and currency
exchange rates against a weighted basket. This has accounted for some but not all of
the appreciation in nominal gold prices.

Real Interest Rates — Once adjusting for denomination effects, real interest rates
serve as a useful proxy of the value of holding purely financial as opposed to physical
assets, thus capturing the opportunity cost of investing in gold. Given the weak
economic outlook, we expect central banks to keep nominal and real interest rates low,
providing the impetus to drive gold prices higher.

Financial Demand — Lastly, gold has seen an unprecedented amount of financial
demand from both retail investors and central banks seeking a safe-haven against
other asset classes. Given the high level of market uncertainty and continued turmoil
from the euro-zone crisis, this financial demand should continue into 2012.

Gold Price Outlook — We forecast nominal gold prices, which averaged $1220/t oz in
2010, to average $1575 in 2011 and $1950 in 2012.

To read the full report: GOLD