Nothing like permit rumours to kick-start the stock price again

Sabre rattling in the Middle East from Iran and Israel is again having a positive impact on the gold price, while other fundamentals are supportive too.

Author: Lawrence Williams
Posted: Saturday , 12 Jul 2008

LONDON -

Middle East war rumours are flying and the gold price is up sharply as a result, although there are a number of other strong fundamentals boosting the yellow metal's price too. Over the past couple of days, we not only have reports of more Iranian missile tests, but also of test runs by Israeli warplanes simulating attacks on Iranian nuclear facilities. How much of this is sabre rattling, and how much is for real will no doubt unfold over the next few days. But whatever happens the threat of further conflict in the Middle East is positive for gold - and extremely worrying for the rest of the world as well as for the potential protagonists.

Not only is Iran threatening Israel and America's Middle East bases with its missiles, but also to cut off the Straits of Hormuz through which a high proportion of the world's oil flows - notably from Ian itself and Iraq. This in turn has had another knock-on effect on the oil price, which had been showing signs of coming back sharply from its peaks - now proven to be a short-lived fall as new all time highs have been reached on the supply threat.

Coupled with the global economic woes and a furthering weakening of the US dollar against key currencies, gold could be set for a good boost if Middle East tensions continue, despite the mitigating impact of the northern hemisphere summer holiday season - traditionally a weak time for the metal.

The recent report from the World Gold council that members of the Central Bank Gold Agreement had sold 297 tonnes of gold so far in this agreement year (which ends in September), suggests that the full 500 tonne quota will not be released to the markets this year is positive for the market, as has been the news of a sharp fall in South Africa's first half gold production. Depending on whose figures you take, it appears that China has already overtaken South Africa as the world's leading gold producer and further changes in the gold production rankings may also be forthcoming with declines in some major producing countries possibly matched by new production elsewhere. But what does seem apparent is that the big gold price increases seen over the past few years have been insufficient to stimulate any significant global gold production increase. Indeed output may well remain flat, or even show a small decline, over the next few years.

There is also evidence that jewellery demand in India, still the world's biggest fabrication market, is beginning to pick up again after a substantial price-related fall-off, while other emerging markets like China and Vietnam are themselves beginning to have a sharp impact as their demand rises along with the increasing wealth of their populations.

We have also heard that investment demand from gold ETFs is continuing to increase soaking up any other surpluses in the gold market, and while gold may not react quite as other commodities do in terms of supply and demand parameters, the tight situation does help underpin the price.

Oil is the big unknown factor though. The strength in the oil price has tended to depress the US dollar and help drag the gold price up with it - hence part of the surge in both oil and gold on tensions in the world's major oil producing region. There are indications, though, that should tensions diminish, oil has been overblown and there could be a sharp fall ahead for us. One suspects though that gold could rapidly decouple from oil in such a scenario, although the initial impacts could certainly be negative for the metal price.

However, with even conservative analysts looking to gold back over $1,000 this year and global economic factors continuing to look bleak and inflation beginning to rear its head across the board, the precious metal's value as an inflation hedge should continue to buoy the price up. Meanwhile investment demand seems likely to continue strong, so one could feel downside risk is perhaps rather less than that of the general stock markets. With the potential of some upside at least while that for stocks in general looks flat or downwards, gold continues to look a good bet as protection against a general stock market collapse.