Gold and currencies outlook
Gold scenario for this year
With gold prices at a historic high, the future trend of gold price is the question on everybody’s mind. There are a few wrinkles which make the future of gold price a complex subject. Gold prices in the coming 1-3 years, may not be a open-and-shut case. Lending stability to gold prices are the following six factors.
- IMF gold sales – IMF has some 3000 tons of gold – of which, some 400 tons have been earmarked for sale. 200 tons has been bought by RBI and another 20 tons by sundry central banks of Sri Lanka, Mauritius, etc. Leaving less than 200 tons on the table. RBI claims that they have put in a bid for the rest also – and the decision on that will be taken soon. Thus, any downward pressure on gold prices due to IMF sale is unlikely.
- Central Bank gold sales – Various European banks have been selling gold from their ‘reserves’ on the open market, over the last ten years. Not much is left from that quota. No downward pressure from this quarter also.
- Chinese Yuan appreciation – The whisper on the street is that the Chinese yuan may see 10%-15% appreciation in the next 4-8 months. This may trigger a re-balancing of the global currency equations, making the dollar weaker in narrow range. This may lead to a welcome lowering of the US trade deficit – which will strengthen the dollar, against non-yuan currency. And re-create some confidence in the US dollar.
- Indian business outlook – Yuan appreciation will end up making the Indian export sector, specifically and corporate sector generally, more profitable. An increase in merchandise export seems unlikely. Improvement in profitability will attract dollar inflows into India for investment in Indian stock markets; increasing liquidity in India, decreasing interest rates and mildly strengthening the rupee.
- Double whammy – A strengthening rupee and a stronger dollar is likely to further put downward pressure on gold prices. For the first time in many years, India has slipped to number two position (by a minor ten tons) as the largest gold ‘consumer.’ Accompanied by the drumbeat of official media, Chinese consumers have been encouraged to buy gold – and comparisons to India are being freely made.
- Gold value is 10% of Indian capital stock – Keep in mind that India is a US$1 trillion economy and India’s 25,000 tons of private gold reserves @Rs.18,000 per tola and Rs./USS$ rate @Rs.45 to dollar converts to US$ 1 trillion also. Adopting a return on capital employed @ 10%, implies total capitalization of the Indian population at US$10 trillion. And gold forms 10% of that capital. Is this an equilibrium in India. From here on, Indian gold demand may well be damped.
“Even if it’s sold at a market price, we should still buy,” counters Xia Bin, head of a key Beijing think tank advising the State Council cabinet (and also making plain that this is his personal view).
“India’s okay with it, why shouldn’t we be? What’s the use for so many dollars, whose purchasing power is weakening anyway? With so many foreign reserves in hand, I think China should buy, without doubt.”
One tremor is all
What can trigger a fresh upward burst in gold prices, can be any of the following events.
One tremor, in the market, on any of these triggers, will set off another stampede towards gold.
Depending on the event, the next breather gold may then take will possibly be at US$1800 (ounce)/ INR25,000 (tola).
As the last one year unfolded, the Citi, GM, rescue plans, have strained the US Treasury. The next upheaval may be sovereign debt.
How can Greece, Spain or the UK unravel the EU
Greece, Iceland, Ireland, Spain, UK et al are tethering at the brink. If they regain their balance, world economic outlook may give reasons for optimism – and for gold prices to take a breather. To avoid a default by Greece, Spain or UK, the ECB may need to extend some really big sums of money.
What makes these five cases specially worrisome, is the near-absence of manufacturing and industrial output in these countries. Unlike France, Germany or Italy. This may make EU-member countries balk at extending lines of credit, sovereign guarantees, underwriting of new loans, interest /capital waivers, rescheduling of debts, rollovers – the works.
Defaults by any or all names. Without credit lines, loans, underwriting, guarantees to these on-the-edge countries, may set off an exodus or a break-up of the EU.
Can Russia and China become a problem?
Russia has seen a major drop in export income, due to crash in oil and raw material prices. Yuan appreciation in the China could the other trigger. But these two scenarios may take 2-5 years to play out. These may not be the reasons for the immediate run-up on gold prices.
But to get a real perspective on how changes in gold prices can happen, the Soviet Gold saga is worth looking at.