Will the golden era continue

To answer this common let us revisit the last decade and try analysing what made gold prices rocket. The rally in all the asset classes including gold was led by a secular bull run which started from the end of 2000. The Alan Greenspan reign triggered a rally in asset prices,as he reduced interest rates from a peak of 6.5 per cent to 1 per cent in mid-2004.

During this period,gold posted a gain of 72 per cent from 278/Oz to 450/Oz. This was when the carry trade and sub-prime lending created liquidity,sweeping out of balance the asset market which then accelerated asset price inflation. Excess leveraging in the housing market and cheap money flowing freely sparked inflationary pressures,making gold a superlatively attractive bet. Markets witnessed the rise in US CPI from 1 per cent in Mid-2004 to nearly 3 per cent by September 2007,during the period which gold rallied by another 70 per cent to 730/Oz in May 2006.

As inflation continued to creep up,rates were tightened back to 5.25 per cent by Sept-2006,after which gold consolidated between 700 and 550 for a year. But starting from the last quarter of 2007 till March 2008,there was a significant unexplained rally in all the asset classes,which was then associated with a huge Yen carry trade taking place at that time. We saw cheap money driving gold again as it rallied by another 53 per cent to cross the 1000/Oz mark for the first time in March 2008,just before the collapse of Lehman Brothers.

Gold corrected significantly after the Lehman catastrophe as liquidity was sucked out of the markets due to rapid deleveraging. So by November 2008,gold corrected by 33.4 per cent. Just then the Fed announced its first Quantitative Easing programme QE1,through which it bought 2.1 trillion worth of mortgage backed securities MBS till June 2010. During this period,gold rallied by another 85 per cent,reaching above 1,264/Oz. In November 2010,we witnessed another round of QE which included a co- ordinated liquidity push by all major banks,giving an extra push to gold prices,pushing it above ,1630/Oz in July 2011,when QE2 ended.

The last leg of the rally in gold was a truly spectacular one which saw a genuine safe-haven demand,pushing gold above 1,900/Oz due to European debt problems,which has caused us to question the very existence of the Euro. This makes it very clear that for gold to rally,you need free flowing and cheap money because gold is a non-yielding asset and it never performs in a high interest rate or tight liquidity scenario.

Where are we now?

We are stuck between the high growth emerging nations who are fighting inflation and a set of developed countries struggling to keep afloat with their banking system struggling for money. There is no cheap money easily available. With the end of QE2,markets were desperately looking for QE3,but robust economic numbers from the US have kept the Fed on watch before taking any action while the European credit squeeze has dried up the precious dollars from the system.

Today,the banks are struggling to raise capital and sovereign nations are finding it difficult to pay off their mounting debts while relentless austerity continues to kill the consumers in Europe.

The next three months look extremely difficult for gold as money will continue to dry up. Gold will then serve as an instrument to get some money out of and we will see gold suffer the most without any further monetary reflation. Historically,whenever gold corrects,it falls by a decent 30-35 per cent and currently it is already down by 18 per cent from the August highs.

We feel that it could fall another 15 per cent from current levels,which would take it close to 1,380/Oz levels. Since gold in international markets has made a top and started its descent,Indian investors have had an advantage with a nearly 20 per cent depreciation in rupee. Domestic prices have gone on to make new highs,yielding an additional 15-17 per cent. Larger risks continue to loom in the first half of 2012 and the strength in the dollar looks to continue.

Internationally gold would fall but the domestic markets could get some support from a weakening rupee,bringing it near Rs 24,000 levels. The question is whether it makes sense to buy at those levels,but in order for gold to rally,the dollar should correct which means that the rupee should appreciate.

This would erode some of the golden gains in India. So we would suggest that investors should book profits now and look for decent corrections to re-enter,but do not expect any major rally in the next year.

Author is Head -Commodity amp; Currency Research,Anand Rathi Commodities