In this article, we will analyse the main reason of the recent gold rally and why the gold price is overvalued based on the fundamentals. We recommend investors to sell the funds which mainly invest in the gold futures.
- The sharp increase of gold price in 2009 was primarily driven by dollar depreciation and speculation.
- Basic demand on gold recorded a substantial decline in the first three quarters of 2009.
- Central banks’ buying is by no mean justify the high gold price because there were only few central banks to participate into the market and the volume of the buying was insignificant.
- 1-year gold forward price implies the gold price would move horizontally over a period of time.
- The gold price would then experience a nasty correction should the Federal Reserve starts to raise interest rates.
The international gold price once surpassed US$1200 per ounce in December 2009, hitting a historical high without factoring in inflation. The gold finished 2009 up by 24.4%, its ninth consecutive annual gain. Gold price was propelled by the
depreciation of the US dollar and the worries on potential inflation. The continuous uptrend in gold price reinforced the bullish sentiment and provided more incentives for investors to speculate on gold.
Downward Risk Is High For Gold Price
Apart from the expensive price, there are some other negative factors on gold. In fact, we don’t see any threat of hyperinflation. The breakeven rate for 10-year US Treasury, which is an indicator of inflation expectation, was at moderate level of 2.3% as of 31 January 2010. In addition, global economy has just started to recover and investors have regained their risk appetite. Hence, the demand for riskier assets has increased. Coupled with the weak demand for gold, gold price is likely to correct down.
Chart 5 shows that the gold-forward prices have continued to drop since December 2009. It implies that the market expects the gold price to drop in the future and thereby investors have been selling forward contracts. The decrease in gold forward rate may also reflect that investors have started to reconsider the gold’s fundamentals and the negative factors such as the rate hike in US which would probably drag down the gold price. As at 29 January 2010, 1-year gold forward price was US$ 1088, indicating that gold price will remain vulnerable for 2010.
Besides, investors should note that gold does not provide interest income. If the Federal Reserve starts to raise interest rates, investors will re-embrace the US dollar and re-price on gold. The gold price would then experience a nasty correction. Therefore, we recommend investors to avoid funds with exposure to gold. Investors can consider selling funds with holdings of gold equities .
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