TOO FAR TOO FAST?
Gold - a pause for thought

Has gold risen too rapidly in its latest price moves? While long term prospects remain good, short term volatility may move the price downwards as external factors come in to play.

LONDON -

The big question facing the gold investor now is has the metal price moved too far too fast. The emphatic answer from the gold bugs is no - but they have been wrong before. Still many of the fundamentals point to further increases and many pundits predict perhaps $800 this year - but I'm not so sure.

There is certainly a strong element of selling in the market with prices being pretty volatile on a day by day basis, and there are some huge short positions out there which suggest that some of the big financial institutions are expecting a downturn. It probably wouldn't take much to knock the price back $10-20 or more. Strong Central Bank sales and any, even shortlived, sign of dollar strength could have this effect, particularly as non-US monetary authorities and governments may see a rapidly declining dollar detrimental to their own economies and take steps to stabilise the situation in the short term.

On the Central Bank side, the Swiss last year announced the intention to offload 250 tons of gold by the end of 2009, of which 137 tons was outstanding at the start of this CBGA (Central Bank Sales Agreement) sales year which started September 27th. The timing of the continuation of such sales could be key to the short term performance of the gold price. And we do not know yet which, if any, other CBGA banks may sell gold in the year ahead - a quota of 500 tons is available.

The big fundamental demand for gold comes from the jewellery sector, and one has to consider also that the jewellery fabricators may start to hold off purchases in the hope of a downturn in the price.

To an extent, though fundamentals of supply and demand probably do not make a great deal of difference in the long term gold price trend. Whether world gold production increases by a few tons or declines, or whether jewellery fabrication demand rises or falls at any point in time, is probably not that relevant in the scheme of things, but it can affect the short term price position. And if you are a short term trader in gold this could be relevant.

Longer term, though, the prospects for further gold price increases remain good. The gold price remains basically an indicator of strength, or otherwise, in the US dollar and most observers see further declines in the value of the greenback ahead as the US tries to get to grips with its massive deficit.

So, the pause for thought relates to short term factors which may depress the gold price from current levels, or keep it on a plateau for the time being. Gold is, and has always been, a special case since its price was freed from the dollar. It does not follow other supply/demand trends - if it did it would be at hugely higher levels now than it is -most base metals have performed far better over the past five years for example.

Ultimately, though, assuming the US economy remains weak, and there continues to be an apparent US effort, however much denied, to drive down the dollar's value against other currencies to help mitigate the deficit problem, gold's underlying strength remains. If you're in gold for the long term it should prove a decent investment - perhaps even a spectacular one. In the short term there may be volatility ahead which could take the price down as well as up.