2009 Gold Outlook

By Brian Dolan, Chief Currency Strategist

What does 2009 hold for gold traders?
See what FOREX.com's Chief Currency Strategist thinks.

FOREX.com's Current Outlook on Gold

Gold has seen a sharp appreciation since late 2008, rising around 42% from around $700/oz to an 11-month high just above $1000/oz on February 20, 2009, as global stock markets made fresh declines and investor anxiety remains elevated. (Spot gold reached its all-time high of $1032.70/oz on March 17, 2008; spot gold's highest daily close was at 1002.95/oz on March 14, 2008.) What are the main drivers behind the recent rise in gold?

On the industrial physical demand front, the high relative price of gold has undermined demand for gold jewelry, while the global recession has weakened personal consumption overall, further denting jewelry demand. Industrial demand for gold has been similarly weakened as the global downturn has hit personal consumption, reducing demand for products that utilize gold in the manufacturing process, such as consumer electronics and automobiles. In short, industrial physical demand for gold is weak and unlikely to recover significantly until the global downturn begins to stabilize.

Some analysts see gold's rise as the result of fears that massive government fiscal stimulus spending will lead to higher inflation in the years ahead. However, in our view for the near-term, the synchronized global recession makes the risks of deflation the greater threat, undermining the case for gold as an inflation hedge.

The primary source of gold's appreciation, in our estimation, is investor fear as traditional asset classes (read: stocks) have yet to show any signs of stabilization. In addition, sovereign credit rating downgrades, and fears of more to come, are undermining investor faith in many major national currencies, which helps explain why gold priced in EUR, JPY, GBP and other currencies has just reached new record highs. In a break with the traditional relationship, gold has appreciated alongside the USD, with both appealing as safe haven assets. We think gold's gain is a heavily sentiment-driven effect and is highly vulnerable to a reversal should risk appetites begin to improve in anticipation of the recession's nadir and expected stabilization/recovery.

We also see many contrarian signs that the gold price rise may be entering bubble territory. Chief among these is the surge in popularity of gold ETF's and the demand for gold coins and other physical forms among individual investors. People who have never owned gold are suddenly drawn into a 'can't lose' proposition, which is eerily similar to the real estate bubble. Other indications are the purported drop in confidence in fiat money (paper currency) even as international investors continue to snap up massive new government debt issuance. Lastly, gold commentators appear to be trying to outdo each other with progressively higher price forecasts, with some now topping $2000/oz. and some even as high as $3000/oz. Dow 36,000 anyone?

From the technical side, gold has formed a clearly defined price channel higher, while momentum studies point to a bearish divergence, suggesting price gains have become extreme and are in danger of a downside reversal. We are mindful that the $1000/oz level holds tremendous psychological significance, but it now also holds major technical significance, with the last venture above resulting in a sharp reversal lower. With the Feb. 20 high just above $1000 and subsequent retreat, we are left with a potential double top formation, which may signal a longer-term, multi-year high. We are watching the channel base at $945/oz currently and we would look to short gold on a daily close below. A daily close above $1050/oz will likely be needed to signal gains higher into uncharted territory.

Gold Trading Fundamentals

Gold holds a unique place among commodities in that it is both a physical commodity and a financial asset. Gold's physical uses are mainly for jewelry and industrial applications, especially in electronic circuitry across a whole range of industries. Gold's place as a financial asset primarily stems from its historical role as a store of wealth, particularly during times of crisis or when other asset classes are seen to be under-performing.

As a financial asset, gold has many different roles ascribed to it:

• Hedge against inflation--When inflation expectations are high or rising, gold tends to appreciate while other asset classes may see values eroded by inflation. When inflation expectations are low, gold may languish.
  
  
• Alternative to USD--Gold is frequently referred to as a second international reserve currency after the USD. During periods of pronounced USD weakness, gold may tend to appreciate as investors seek security in physical commodities. When the USD is strong, gold may lose its relative luster.
  
  
• Safe haven vehicle--during periods of heightened risk aversion or market turmoil, gold tends to appreciate as investors exit other financial assets (e.g. stocks and bonds) and flock to the traditional role of gold as a store of wealth. When primary financial markets are stable or rising, gold may lose attractiveness to those markets offering better expected returns.

Unlike most other financial assets, however, gold does not offer an interest rate return. Instead, the return on gold is based solely on price changes. (Gold typically has a small cost of ownership based on physical storage requirements.) The lack of an implied rate of return tends to see gold appreciate only when investor anxiety is high or rising, making investor sentiment an important determinant of gold's direction.

Disclaimer: The information and opinions in this report are for general information use only and are not intended as an offer or solicitation with respect to the purchase of sale of any currency or metal. All opinions and information contained in this report are subject to change without notice. This report has been prepared without regard to the specific investment objectives, financial situation and needs of any particular recipient. While the information contained herein was obtained from sources believed to be reliable, author does not guarantee its accuracy or completeness, nor does author assume any liability for any direct, indirect or consequential loss that may result from the reliance by any person upon any such information or opinions.