The gold dichotomy: Demand rises, prices fall
Today's Financial News - Posted November 19, 2008
There are a lot of forces impacting the gold market, yet prices are barely moving. Demand is soaring, but prices are dropping. What gives?
By Andrew Snyder, TodaysFinancialNews.com
Baltimore – (TFN): It is an interesting time for gold investors. On one hand, gold prices should be soaring as investors flee to the precious metal for security. On the other, gold’s value should be dropping precipitously as deflationary concerns gain momentum.
It is no wonder gold prices remain horizontal and the gold hedge I recently created is paying profits. Last week we cashed in for gains of up to 50%.
Some interesting reports released today will help illustrate why gold prices are acting the way they are.
First, let’s look at the demand side of the equation. Global orders for gold increased by over 120% during the third quarter on a year-over-year basis. Retail investors moved 232 tons of the metal, compared to 105 tons this time last year.
Exchange-traded funds (ETFs) significantly boosted their physical possession of gold over the past three months. Third-quarter holdings increased by 150 tons. During the second quarter of the year, they only added 4 tons of gold.
These figures are proof that global demand is soaring. But why are prices staying flat and showing signs of a serious collapse?
They want it, but we don’t
There are two answers. For the first, we have to look at the situation here in the States. During the previous quarter, Americans demanded 20% less gold than the same period a year ago. Thanks to a strengthening dollar, American investors are shying away from gold as it typically moves inversely to the greenback.
Remember, gold is a vehicle used to protect against inflation. Right now, the American economy is anything but inflationary. The headline reading of the latest producer price index, released yesterday, showed a record 2.8% decline in wholesale prices last month. Today’s consumer index confirms the deflationary environment with a negative reading of one percent.
Deflating prices will be a major drag on gold’s appreciation. Enough American investors will be dumping their gold holdings in exchange for stronger assets to nearly offset the significant increase in global demand.
If a deflating economy is not enough to drag gold valuations down, the fact that institutional investors are abandoning the metal certainly will. The world’s largest funds unloaded 300 tons of gold recently. As they are forced to meet margin calls or as their investors cash out, institutional investors are unloading their gold holdings as the metal is liquid and, compared to their other holdings, has held much of its value.
By reviewing this information, it is easy to see why gold prices have made relatively little moves over the past three months. When prices get pulled in both directions, they tend to stay put.
Something’s gotta give
Eventually one of the forces will give and gold valuations will make a significant move. If the break is caused by a slowdown in global demand thanks to signs of economic recovery, gold prices will plunge. If it institutional sellers stop unloading while global demand is at record levels, prices will soar.
History and basic economic principles point towards falling prices so I am naturally bearish on gold’s long-term valuation. But there are plenty of folks that tell me I am wrong. As the world economy tanks and the U.S. floods the market with its currency, they say, gold price will soar.
Never one to invest unprotected, I created a hedge play that will profit no matter which way valuations move over the next year. If I am right, the bearish leg of the hedge will win. (Last week we proved my theory by cashing in gains of over 50%). And if I am wrong, the bullish side will win. No matter what, the hedge is designed to pay out profits.
If you want to learn about this unique hedge, click here.
This is an interesting time for investors. Never before have so many unique, yet infinitely strong forces, tugged at the market.
As we slowly weigh and understand all of the variables, the economic future will become clear. But for now, it is prudent to take protection and seek shelter in the opportunities that have historically provided profitable recessionary havens.
Next Article: Covered calls: An easy strategy to win
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