Here are the drivers of gold prices:
1. Its price rises when USD drops. USD is in a secular bear trend. Persistent trade deficit, budget deficit, QE. There may be a minor rebound of the USD against Emerging Market currencies when the stock market corrects but I don't think it will be much. At most, the USDSGD may rise to 1.33, which is less than 3% up. By end 2011, USD may fall to 1.20.
2. In times of war, investors flock to gold for safety.
3. When interest rates rise, gold price falls because investors would rather place money into an asset that gives yields. The USD interest rate yields virtually zero. But EM currencies are raising interest rates faster than you can say "Quantitative Easing". It's a mix bag in this area.
4. New supply. Many countries are raising capex into exploration for gold. Over several years, gold supply should creep up.
5. Jewellery demand is quite stagnant at the moment. India, the world biggest consumer of gold jewellery, has mostly held back its purchase.
6. government selling / buying. I do not think the Chinese government nor any government with big foreign reserves will be aggressively buying gold. They will probably be selling off US Treasuries, but buying foreign assets, especially mining reserves.
7. Technically, gold is hovering between USD1300 - USD1480/oz.
Conclusion: gold has limited upside. The numbers being talked about, USD2000, USD3000, will probably not occur in the next 1 - 2 years. Metals with industrial uses like copper, platinum, palladium, steel will probably have more upside. I would suggest taking some profit off gold and gold mining companies in the near term.
Is Gold Pullback a Correction or a Contrarian Indicator?
Anyone paying attention to CNBC these days may have noticed a disconnect between what guests say and what readers/viewers say.
Readers (judging by their comments) are decidedly bearish on the economy and the markets. For example, whether right or wrong, every comment (as of time of publishing) on recent bullish remarks by Richard Bernstein bashed his conclusion and credibility. The accusations are wild and it appears that rationality has been thrown out the window. There's 'bear fever' out there and retail investors don't want to hear anything that contradicts their view.
In another article, CNBC polls readers on today's gold pullback. The results are telling. 70% of respondents (as of time of publishing) see today's pullback in gold as 'just a short-term correction'. What this tells me is that the retail investor is buying gold on the dip and is bullish.
So retail investors (as represented by CNBC comments) are bearish on the U.S. and bullish on gold.
Viewing this from a strictly contrarian position, my conclusion would be that it may be time to lighten up on gold and buy U.S. equities. Clearly this conclusion does not consider anything but retail investor sentiment. And using investor sentiment to guide investing decisions isn't always accurate - but when at extremes, investor sentiment is often a useful contrarian signal.
So the real question is this: Are bearish retail views on the market/bullish views on gold at extreme levels yet?
