2012: Whither Gold?

By Kevin Michael Grace

Gold has been north of $1,600 an ounce for most of January. Last month, however, it threatened to travel south of $1,500, triggering fears that the long bull market had come to an end. So what kind of price movements can we expect in 2012? North, south or lateral? Resource Clips asked two prominent gold analysts to explain why gold collapsed in December and where it is likely to go from here.

Bart Melek, Head of Commodity Strategies for TD Securities, blames the December drop on “fiscal problems in Europe and a financial crisis that’s starting to come to a head.” He explains, “We’re increasingly seeing financial institutions and other players being forced to cover margins and swap out gold for cash. It’s very difficult for European banks in particular to get funding. The thing to do is sell whatever assets they have to cover margins and other obligations.”

Patricia Mohr, Vice President and Commodity Market Specialist for the Scotiabank Group, blames the drop on the weakness of the Euro vis-à-vis the US dollar and “extreme risk aversion” among investors. She explains that under these circumstances, “Investors shift into cash or into the security and liquidity of US Treasury securities: Treasury bills or short-term treasury bonds.”

As for the first quarter of 2012, Melek says, “There’s a bit of consolidation going on here… I wouldn’t be surprised if we temporarily fell through $1,500.” Mohr ventures, “In the absence of more liquidity injections from the European central bank, I think gold may languish for a while.” For how long? “I don’t know. Gold is a commodity that runs up a lot quickly, and then there’s a great deal of profit taking.”

Melek adds, “We’re seeing much less liquidity within the market; people have been de-risking, and volatilities have increased. Investors were forced to liquidate, so you have relatively few players in the market.”

And those players are for now taking the short view. Melek says, “At the end of the day you’re going to get paid. It’s basically like this, you have this huge storm out there, and you know that if you put your capital in dollars or treasuries, this is the grain that mice and rats are going to eat bit by bit. That’s your negative real rate of return, but you’re going to keep it away from the storm. Even if it doesn’t make longer-term sense to liquidate an asset like gold, which ultimately will do extremely well in our opinion, you do it because you have to.”

Mohr concurs with Melek regarding the newly crucial importance of volatility. “On a very bad day, on a day where investors are really risk averse and selling everything, they’re willing to work into US treasuries because of the huge liquidity in the market and the fact that the US government backs US securities. That’s quite counterintuitive, but something that is very definitive, we’ve seen it for a long time now.”

Both analysts are of the opinion that gold’s fate in 2012 is tied to Europe’s. Mohr says, “Our view is that the European Central Bank will have decided [by the second half of 2012] to use its balance sheet to backstop some countries at risk, places like Italy and Greece, to deal with the worst of the financial crisis. At the end of the day this will prove to be positive for gold.”

Melek says, “As far as the fundamentals are concerned, this is still among the best environments for gold that we’ve seen since the post-World War II era. There’s potential for more quantitative easing from the ECB at some point when it decides to stabilize the system, from the Bank of England and of course from the Fed. Lower interest rates from the ECB are coming. We’re seeing extremely high deficits in the USA and around the world, and this will be motivation to monetize.”

Will gold approach $2,000 this year? Mohr replies, “For 2012, I’ve been talking about $1,650, maybe $1,675. I’m not in the camp that has it moving up to $1,800. But you could get $1,800 easily if the European Central Bank applies what is effectively quantitative easing across Europe to bolster the Eurozone.” Melek replies, “We expect it to surpass $1,900.”