As the global financial crisis continues to unwind, many investors and market observers have been scratching their heads as to why the price of gold - often considered a key safe-haven investment during times of uncertainty - has declined. The analysts at Blanchard and Company offer an answer and predict where the metal is headed over the coming quarters.
First and foremost, says Blanchard Chairman and CEO Donald Doyle, is the sudden and unexpected strength of the U.S. dollar, particularly in light of the world's financial system on the verge of a total meltdown.
"In recent months, the dollar has been the beneficiary of the global flight from risk as well as the unwinding of debt made with borrowed dollars," Doyle says. "That's come as a surprise to many who expected that increased government spending and a collapsing U.S. economy would cripple the dollar. Instead, there has been a steep decline in most currencies against the dollar as investors continue to seek safe investments and as other countries appear to be in even worse shape than the U.S."
Doyle pointed to the fact that the dollar has strengthened 8 percent against a trade-weighted basket of 26 currencies since September, and as gold is bought and sold in U.S. dollars, any increase in the value of the dollar causes the price of gold to fall, despite the tremendous amount of physical demand that has been created by the implosion of global markets.
Another factor supporting the dollar has been the crash of many emerging market currencies, Doyle says, including the Brazilian real and the Mexican peso, both of which have declined more than 40 percent against the dollar in a matter of weeks.
"The rise in the dollar and gold's sharp decline in dollar terms have overshadowed the fact that gold prices have stayed strong in the local currencies of large consumers such as India and Turkey," Doyle says. "Even in Euro and sterling terms, gold is still trading significantly higher than it was a year ago."
And as the global economic crisis continues to be sorted out, Doyle says institutional investors have sold gold holdings in ETFs and liquidated commodity portfolios to make margin calls in distressed assets, further driving down the price of gold.
But, physical demand for gold is robust, and investors have been paying abnormally high premiums for gold bullion due to the lack of tangible supply in the marketplace, Doyle says, and much of that influx of money into gold is coming from stock mutual fund withdrawals that are looking for a safe home.
"This year, investors will have withdrawn more from stock mutual funds than ever before," Doyle says, "and while the price of gold has declined, more people are parking part of their nest eggs into the safe haven of this commodity."
SO, WHAT'S NEXT?
Doyle says the inflationary pressures of the U.S. Treasury's financial bailout package will produce a powerful downward adjustment in the dollar, and that a further drop in the dollar is inevitable over the next few years, given the large U.S. trade imbalance, noting that there is no precedent for a country with such a large external deficit to avoid a major currency depreciation.
"Once the economy finds its track, dollar weakness is going to drive gold above past record levels, and demand for tangible assets like gold will continue to grow," Doyle says. "Fundamentals will re-establish themselves as the driver of the gold market, and we believe we'll see $1,250 gold during this period."
