Gold has offered one of the best returns for investors over the past decade. In dollar terms, gold prices have risen more than six-fold since the lows of 2001. In rupee terms, the rise has been even more spectacular. Since their peak in mid-2011, however, gold prices have traded sideways in a progressively narrower range. Have we reached the end of the current bull run in gold prices? Let us consider five key supports for gold prices to see if their effects are beginning to fade.
Much of the G3 fiscal crisis could have been characterised by "can't pay, won't pay". Despite huge efforts in the form of fiscal austerity, Europe has struggled to bring its deficits under control, whereas in the US, authorities have continued to stimulate the economy at the expense of higher fiscal deficits. After two years of painful austerity, Europe is slowly moving towards greater fiscal sustainability. In the US, politicians are finally grasping the nettle of fiscal retrenchment, with tax increases already in place and spending cuts likely to follow at the end of the month. We could still be some way off a final solution. But on both sides of the Atlantic we are slowly moving away from debt monetisation and towards fiscal sustainability.
Quantitative easing offered a huge boost to gold prices, by depressing long-term interest rates to abnormally low levels, as well as helping to weaken the dollar. But in targeting QE3 directly at the mortgage market, the US Fed is now attempting to boost growth, rather than devaluing the dollar.
Between 2008 and 2011, central banks of developing countries increasingly turned to gold as a means of reducing risk, as well as enhancing return, within their foreign exchange reserves. But, by 2012, much of this desired diversification had already been achieved. Although net central bank holdings of gold continued to rise in 2012, the lion's share of this came in the form of gold reserves deposited at the central bank of Turkey.
China's demand for gold has increased exponentially over two years. In large part, this occurred due to a lack of viable alternatives for Chinese savers and investors. But as the current economic recovery is accompanied by rising real estate and equity prices, and with real interest rates positive once again, Chinese demand for gold could gradually diminish.
Indian demand for gold has been strong, supporting higher gold prices for the last decade. But even this source of demand can no longer be taken for granted, as Indian authorities seek ways to reduce gold imports, in order to stabilise the country's external imbalances.
In each case, the potential support from these key sources of demand is getting progressively undermined. This introduces growing downside risks for prices.
In the near term, concerns over the ability of G3 governments either to bring their deficits back under control or achieve acceptable levels of economic growth mean that gold prices could continue to be supported at their current levels through risk aversion and quantitative easing. But, should economic growth and fiscal retrenchment in the US and Europe become attainable, gold's 12-year bull run could soon go into reverse mode.
The author is head of commodities research, commodities markets, Natixis, London. (The views expressd are personal)