Gold waits on contrarian sentiment to emerge

As the quantitative easing (QE) phenomenon goes imminently into decline in the US, the hopes of bulls in the gold market have already been dispersed.

By contrast with the seemingly unperturbed air of the oil market in 2013, the precious metal was caught in a maelstrom of negative forces once it became apparent, most crucially, that unprecedented injections of monetary stimulus were not leading to significant levels of inflation.

As the US economy appears on the cusp of reaching the escape velocity, which policymakers have hoped for, a gloom has descended over gold — as it seems growth is being attained without sparking prices in such a way as to invoke the degradation of the dollar.

Moreover — although it represents also a potential lifeline for gold’s advocates — as the Federal Reserve’s tapering exercise gets under way, the bond market may back up (without central bank buying on the same scale) and quell any burgeoning recovery as yields rise.

That possibility inevitably puts a further dampener on prospects for the gold price, although it logically then calls for a further bout of QE that conceivably could rekindle investor interest. Otherwise, there may be a self-equilibrating trap in play, a scenario of perpetual slow growth and slow inflation that some economists have already alluded to, prolonging a bearish mood.

It’s certainly been hard to imagine the kind of economic overheating, of faster growth in tandem with faster inflation, that the gold bugs might feed on.

A core explanation of the world’s financial crisis was that it was not merely a reaction, albeit severe, to a boom cycle, but a cyclical bust mixed with a structural meltdown in financial sectors, with potentially catastrophic consequences for government and national finances and economies.

So it won’t easily be overcome, and the effort to do so will take time, which is an unwelcome trait for gold investors, as there is no yield in common with their capital position to sustain spirits during the waiting game.

Western institutions especially put their speculative gear into reverse in 2013, with something in excess of 800 tonnes drawn from gold-backed exchange-traded funds (ETFs), the first outflow for 13 years.

As a review by Dun & Bradstreet observed last week, gold price dropped by the most for more than 30 years (28 per cent), from around $1,675 (Dh6,152) to $1,200 per ounce, as investors were encouraged into risk-bearing assets.

Over the seasonal holiday period it has both dipped below the $1,200 level and then bounced back upon so-called technical buying, since the low-point in 2013 of $1,180 was not broken, whereby a further wave of selling would have taken effect.

Of course, while the US has remarkably reasserted its dominance over confidence in international financial markets, in conjunction with China’s uncertain performance, QE is not confined to the States. Europe may not be playing along, but Japan’s stunning entry into this domain shouldn’t be ignored.

The Japanese government’s Abenomics strategy, nominating a positive inflation target of 2 per cent in the hope of enabling economic growth, has entailed an enormous expansion of the central bank’s balance sheet, an effective absorption of trading in government bonds, and the provision of rocket fuel for the stock market.

Given that Japan remains the world’s third largest economy, that’s not to be sniffed at as a global influence, behind the twin motors of the US and China. Its monetary base has doubled in two years, with spillover effects abroad.

Even so, the spectre of accumulated debt haunting both governments and households across the globe, is a dragon that won’t be slain overnight, and the corporate sector, while relatively flush with cash in many regions, is not inclined to accelerate production and investment in that environment.

As a collective picture, it would seem the world economy is sufficiently mired still that any kind of normalised progress is likely to be a grind.

Of course, other factors are involved in determining gold’s fate.

Oversupply has become apparent, as the highs of past price trends have fed mining production, with output set to rise again in 2014, as it did last year, to some 3,000 tonnes.

Other forms of demand, most obviously the physical markets of India and China, are a mixed bag. The Indian government’s tariff on gold imports, attempting to curtail balance of payments pressures, has stifled sales, a shift unlikely to be reverted. By contrast, China is expected to swallow over 1,000 tonnes of bullion this year, whether for retail jewellery purposes or hoarding by the state.

Many will know it’s often when virtually everyone becomes convinced of a trend that it is primed to break, and the contrarian investor is willing to take a chance on timing that turnaround.

Right now, it does seem that sentiment is loaded against gold, which makes that scenario a live one.