Speculation over the magnitude of the Fed’s anticipated quantitative easing continues to drive gold metals markets

Speculation over the magnitude of the Fed’s anticipated quantitative easing continues to drive precious metals markets, especially gold. Yesterday expectations that the intended monetary stimulus would be large were fuelled after the Fed surveyed bond dealers asking how asset purchases might influence yields.

Estimates for QEII are as high as $2tr, although consensus remains for around $500bn as an initial announcement next week. As stated yesterday, we believe the risk is that the Fed will disappoint the markets, and rather announce a staggered approach with smaller amounts of asset purchases on a monthly basis. If so, gold could fall next week.

Nevertheless, we place a floor of $1,280 on the gold price, as this is the price we find consistent with no additional stimulus. This morning, gold and silver have come under pressure as the dollar regains some lost ground. Physical selling and investor profit-taking has added to the downward pressure, although the market is relatively thin. Seasonal jewellery demand (Diwali
next week) could prompt some price support in the dips.

Gold support is at $1,327 and $1,313. Resistance is at $1,351 and $1,360. Silver support is at $23.62 and $23.29, resistance is at $24.15 and $24.36.

The physical gold market has undergone a marked change in the past week

The physical gold market has undergone a marked change in the past week. Until last week the physical market has provided resistance to a higher gold price - now it is providing support. We have seen strong physical selling and scrap gold coming to market since mid-September, as the gold price pushed higher.

However, the latest decline in the gold price to below $1,330 has spurred renewed physical buying interest. As a result our Standard Bank Gold Physical Flow Index (GPFI) has jumped into positive territory after lingering in negative territory for almost more than a month

The buying interest is spurred by two events:

• Firstly, ahead of the end of Diwali on 5 Nov, India buying interest should remain strong on any price dips. This buying on pull-backs in the gold price may fall away after next weekend. Short term this warrants some caution.
• Secondly, we believe the buying interest is an indication that the physical gold market is slowly adjusting to the higher gold price and now sees a “higher low” in the gold price as a buying opportunity.

Long term this is a bullish sign. We continue to expect gold physical demand to prevail on dips.
However, the demand on dips might not be as strong as it has been the past month. While Indian demand may fall away towards mid-November, we still have the festive season in the Western
Hemisphere as well as Chinese New Year. In 2011 Chinese New Year is on 3 February.

We note that physical demand is dominated by investment demand. As a result our main focus remains the action of the Fed next week. With regards to the Fed actions - we believe the gold market is pricing $500bn of QEII already. Our estimates are based on gold's close relationship since 2004 with global liquidity of which the Fed's balance sheet makes up an important component. We find a gold price closer to $1,280 would be consistent with no additional QE.

Interpretation of QEII still look at gold

The market still focuses on QEII. Investor commodity interpretation of QEII still look at gold. They believe the gold market is pricing $500bn of QEII already. Our estimates are based on gold's close relationship since 2004 with global liquidity of which the Fed's balance sheet makes up an important component.

We find a gold price closer to $1,280 would be consistent with no additional QE. This is roughly 4% lower than current price level. Investor are confident the Fed will announce more QE. Therefore, until 3 Feb we see $1,280 as a floor for gold and any price dips in gold should be bought. We believe the Fed is unlikely to do $500bn in one go. As our G10 macro economist points out, the Fed should prefer smaller amounts every month, with the time frame largely dependent on the underlying US economy. This should focus market attention away from monetary easing towards the macro economy.

With gold falling below $1,330 physical demand for gold has picked up markedly since the start of the week. Buyers in Asia and India in particular should continue to buy these dips ahead of the end of Diwali on 5 Nov.

Gold support is at $1,315 and $1,305, while resistance is at $1,329 and $1,339.

Gold have been hit hard as investors take profits and adopt a wait-and-see approach

Gold have been hit hard as investors take profits and adopt a wait-and-see approach ahead of next week’s FOMC meeting (2-3 Nov). Growing uncertainty over the magnitude of the Fed’s second-round of quantitative easing has seen a resurgence in the dollar and an accompanying push lower on commodities. The consensus has been for around $500bn in monetary accommodation, though conflicting signals from recent data flow and comments by Fed members seems to have dampened these expectations.

Yesterday, US consumer confidence showed an encouraging increase, but also revealed that Americans’ view of the labour market has worsened. The Fed’s Dudley spoke yesterday saying that the recovery has been “tepid” and that more stimulus is “likely warranted”, while Fed member Hoenig reiterated that further quantitative easing would be a “dangerous gamble”.
Given this uncertainty we expect precious metals to remain largely range-bound with a bias to the downside ahead of next week’s meeting, as investors continue to lock in profits or opt to remain on the sidelines. Limited physical buying might provide some support on dips.

Gold support is at $1,325 and $1,319. Resistance is at $1,342 and $1,351. Silver support is at $23.26 and $22.81, resistance is at $24.06 and $24.40.

Better then expected housing data helped the dollar recover and took the metal to a low

Market Commentary
Gold moved higher overnight on dollar weakness after G-20 officials vowed to refrain from competitive devaluation, leading us to an open of 1344.00/1345.00. Better then expected housing data helped the dollar recover and took the metal to a low of 1332.50/1333.50. A slow move higher for the remainder of the session took us to a close of 1338.25/1339.25.


Technical Commentary
Gold has started the week moving higher to current 1342. The metal tried last weeks bounce high of 1349 but the level held again. Fridays low near 1315 coincides with our two month trend line. We have been bearish Gold for the past week due to the reversal price action off 1387.
Buying interest came into the market toward our bullish trend line. 1355 is our important pivot. While below 1355 we believe there should be another test to the down side.

Precious metals continue to benefit from market expectations of quantitative easing

Precious metals continue to benefit from market expectations of quantitative easing. A US consultancy yesterday stated that they thought the Fed would be releasing $500bn over the next 6 months. This fuelled dollar weakness and brought gold within reach of the $1,350 mark. As highlighted yesterday, we believe that a gold price of $1,350 is consistent with $500bn of quantitative easing. Adding further impetus to the dollar’s fall were comments by German Chancellor Merkel that it was time to consider exit strategies.

Comments by US Treasury Secretary Geithner that the world’s major currencies are “roughly in alignment” saw the dollar surge briefly, prompting a slight pullback in precious metals in early trade. Soon, however, investors returned to precious metals as expectations over increased liquidity (Fed monetary easing) once again took hold.

Gold support is at $1,333 and $1,324. Resistance is at $1,351 and $1,359.

Investors are still buying dips in the gold price

Investors are still buying dips in the gold price. Investor expect this to continue for the next two weeks. As for seasonal jewellery demand, we expect it to remain robust until the first week of November.

We maintain the gold price at $1,350 is consistent with quantitative easing by the Fed of $500bn. Anything less may see the gold price lower. Empirically, we find the long-term causal drivers of gold are global liquidity and real interest rates. Lately, gold has diverged by some margin from the long-term trend provided by these causal drivers. Divergence by gold from this longterm trend is not unusual, but the speed, size and timing of its divergence coincide with the increasing expectations for further QE.

We find that for global liquidity to be consistent with the current gold price around $1,350, the Fed would have to expand its balance sheet by $500bn.

Gold support is at $1,331 and $1,322. Resistance is at $1,346 and $1,352.

Movements in gold prices remain dominated by the dollar

Along with most other commodity markets, movements in gold prices remain dominated by the dollar. After starting yesterday on the back foot, renewed dollar weakness saw precious metals regain lost ground on investor demand. Physical demand once again all but evaporated as prices rose.

Today, comments by the US Treasury Secretary have lent the dollar some support, prompting a slight pullback across the precious metals complex. Treasury Secretary Geithner committed to working “very hard” in order to ensure that “confidence in a strong dollar” is preserved. Unlike yesterday, the dip in prices, has failed to attract significant physical buying in gold and silver.

The dollar’s gains are expected to be temporary, as the markets once again focus on further quantitative easing by the Fed. As such, we expect to see investor demand return to gold and silver markets.

Gold support is at $1,356 and $1,343. Resistance is at $1,378 and $1,388.

The risk remains that the Fed could disappoint in the size of QE

The dollar has been strengthening against the euro and also on a trade-weighted basis since Friday afternoon following statements by the Fed regarding its view on the US economy and the need for further quantitative easing (QE). However, the market focus has shifted from whether more QE will take place to how much QE is in the offing. We believe that the gold market is pricing quantitative easing of $500bn (based on the gold price’s strong casual relationship with global liquidity and the Fed’s balance sheet). We believe that a figure less than $500bn could see the gold price decline.

US break-even inflation (as derived from US bond yields) is still rising. The bond market is pricing low inflation for the next two years, rising steadily towards and average inflation rate of 2% over the next 10 years. The 10y breakeven inflation rate is now just above 2%. The 5y breakeven inflation is at 1.6% and 2y breakeven inflation at 1%. If the average inflation rate over the next two years in the US is going to be 1% (as priced by the bond market) and the US Fed implicitly targets 2% inflation, we expect interest rates to remain low for the entire 2011 and possibly 2012. Last night the futures market assigns a probability of 82% of no rate increase until at least Sep'11. Low rates and rising liquidity are positive for gold.

Short term, we believe that dips in the gold price will be bought by seasonal jewellery demand in the run-up to Diwali (which ends 5 November). At the same time, we have the FOMC meeting on 3 November which is keeping investment interest alive. We remain cautious on gold post- 5 November. The risk remains that the Fed could disappoint in the size of QE which may be amplified by seasonal jewellery demand which should fall away in November.

Gold support is at $1,363 and $1,343

Expectations of further quantitative easing by the Fed, continues to dominate precious metals markets. Gold and silver have extended Wednesday’s rallies, with gold achieving yet another record price and silver reaching a 30-year high.

Aggressive investor buying is pushing gold towards the next major resistance level of $1,400. In contrast, the physical market remains weak, with gold scrap availability remaining high. Nevertheless, we anticipate some seasonal jewellery demand (Diwali ends 5 Nov) to prompt some buying into dips.

Gold support is at $1,363 and $1,343. Resistance is at $1,389 and $1,395.

Gold Price up from the release of the FOMC minutes

As expected, gold price up from the release of the FOMC minutes, which stated the Fed’s readiness to implement a second round of quantitative easing. Citing that if the pace of economic growth remained too slow “to make satisfactory progress toward reducing the unemployment rate”, the Fed stood ready to provide additional monetary accommodation “before long”. This implies that further monetary easing could be announced as early as the next meeting (2-3 Nov).

However, with no indication as yet of the amount, market estimates vary between $100bn to $1.5tr. The average estimate is around $500bn, which we believe is consistent with the current gold price of around $1350. Expectations of further QE, and the associated dollar weakness, should keep gold buoyant for the remainder of the month.

However, the risk is that the Fed announces a more conservative approach to QE than markets are expecting. A likely scenario might be a staggered accommodative program (for e.g. a $100bn per month), which could detract from gold. Profit-taking and lacklustre physical demand could amplify this downward pressure.

Gold support is at $1,346 and $1,336. Resistance is at $1,362 and $1,367.

Gold could drop below $1,300 in December

Much of the commodity strength, and dollar weakness, of recent weeks comes from expectations of further quantitative easing (dubbed “QE II”) by the Fed. Just how much of this is already
priced in will be key for commodities, gold in particular. We use gold’s strong causal relationship with global liquidity to estimate how much QE the gold market is already pricing in.

Empirically, we find the long-term causal drivers of gold are global liquidity and real interest rates. We define global liquidity as the Fed’s balance sheet plus global foreign reserve holdings (excluding gold). Gold trades around the long term trend these two variables provide. All other factors are short term drivers. Lately, gold has diverged by some margin from the long-term trend provided by these causal drivers. Divergence by gold from this long-term trend is not unusual, but the speed, size and timing of its divergence coincide with the increasing expectations for further QE. We find that:

• Firstly, for global liquidity to be consistent with the current gold price around $1,350, the Fed would have to expand its balance sheet by $500bn.
• Secondly, a gold price closer to $1,280 would be consistent with the Fed announcing no further QE.
• Thirdly, should the Fed provide $1trn in additional QE, a gold price closer to $1,400 should follow.

There are many different estimates of the possible size of another round of QE, ranging from $100bn per month, staggered over a number of months, to a $1trn shock-and-awe infusion. The market will be searching the minutes of the September FOMC meeting for clues on further QE.
With our belief that gold is pricing in substantial QE already, combined with the fact that scrap continues to come to the market at the current gold price, a conservative approach on QE by the Fed could see gold drop below $1,300 in November. This may be amplified by seasonal jewellery demand (which we expect to decline in the December).

While we remain bullish on gold into 2011, we could even see gold at $1,260 - a point at which major technical support lies.

The precious metals markets remain range-bound

The precious metals markets remain range-bound since Friday afternoon, with very little interest coming from the physical market for gold and silver at current price levels. Much of the current strength for gold is still founded in the belief that the Fed will announce more quantitative easing at the start of November. Using the relationship between global liquidity (of which the Fed balance sheet constitute a large portion) and the gold price, we estimate that the gold market is pricing in an expansion of the Fed Balance sheet by another $500bn.

We also find a gold price closer to $1,260 would be consistent with the Fed not announcing any QE during the first week of November. While we remain cautious of gold at current price levels, we believe the metal should still find support into 2011. The IMF/ World bank conference over the weekend led to no solution on the currency wars between major economies. We believe that
the beneficiary is gold.

Central Bank purchasing of gold continues. The latest country to announce an increase in gold reserves is Russia which bought over 100 tonnes of gold from domestic supply. The volume of gold bought is small compared to the larger gold market but the signal to the market is strong — central banks aren’t selling gold anymore.

Gold support is at $1,330 and $1,315. Resistance is at $1,355 and $1,365.

Gold outpaces its long-term drivers

Gold continues its spectacular rally. Indications from the Bank of Japan that it would implement further quantitative easing are assisting gold’s ascendancy. However, gold is now outpacing its
long-term drivers.

For some time now, we have said that the long-term causal fundamental drivers for investment demand in gold is liquidity (not necessarily inflation) and long-term real interest rates. At the moment, both support a higher gold price into next year (see Commodities Insight dated 11 Aug 2010). The BoJ’s announcement yesterday spells a higher gold price. Gold’s relationship with liquidity is confirmed visually (see graph) as well as empirically. We measure global liquidity as the US Fed balance sheet plus global foreign reserves holdings excluding gold. YTD, our measure of global liquidity is up 10%. The gold price is up 18% YTD.

Following gold’s latest rally there is growing divergence between the gold price and global liquidity — the gold price has been rising much faster than liquidity. This is not inconsistent with past behaviour. There are many short-term drivers of gold (such as credit risk, equities and currency moves) which account for these short-term price movements. Furthermore, the difference between liquidity and the gold price is not at an extreme level yet, and we can therefore not conclude that gold is overbought. But we are certainly more cautious with gold at these levels. Speculative length is building, and scrap gold continues to come to the market.
As mentioned in we would not be surprised to see a pull-back in gold.

Looking into 2011, we believe that global liquidity will keep rising as emerging markets specifically further expand their foreign reserve holdings. However, we
expect it to slow in 2011 and 2012 — to only 8% and 5% respectively. This growth in liquidity should support gold.

Gold Price Hits USD1,340 - Any pullback will be buying opportunity

A look at short-term correlations shows that much of the latest rally in precious metals was driven by dollar weakness. At the same time, metals have seen speculative length and open interest rise across the board in recent weeks. In the physical market, scrap gold is coming to the market. We would not be surprised to see a pull-back in gold towards $1,300.

With the Bank of Japan cutting its overnight lending rate to a range of 0%-1% this morning (which spurred a flurry of buying in precious metals in Tokyo) and our expectation for more quantitative easing from the Fed in November, we would see any pullback as a buying opportunity.

Gold support is at $1,311 and $1,300, while resistance is at $1,330 and $1,335.

We would be surprised to see a sharp correction lower in the gold price ahead

With gold having reached our target of $1,300, we expect support to remain in place, mainly from investment demand. But elsewhere in the market, strong resistance to a higher gold price is building.

Macroeconomic factors remain positive for gold investment demand. We see the long-term causal fundamental drivers for investment demand in gold as liquidity and long-term real interest rates. Both support a higher gold price. In recent days, the yield on the 10-year US inflation-linked bond declined to well below 0.70%, implying that the market expects US
real interest rates to average a mere 1% over the next 10 years. A lower implied real yield favours gold investment. Furthermore, our measure of global liquidity (“Fed balance sheet plus global foreign reserves excluding gold”) continues to rise, supporting the current
high gold price (see adjacent graph).

In August, when the physical market supported the gold price, we are now witnessing increased resistance from the physical market. Traditionally, Q4 sees increased demand from the jewelllery sector, but demand is very low right now and there are rising volumes
of scrap gold coming to market. At the same time, net speculative longs on COMEX are close to an all-time high, at 901 tonnes, making us even more wary of a short term correction in the gold price.

We would be surprised to see a sharp correction lower in the gold price ahead of the FOMC meeting next month as we’d expect further quantitative easing. We would therefore buy gold on dips until that time. We remain constructive on gold in 2011. However, we believe that gold may see a sharp correction lower towards year-end 2010 as seasonal jewellery demand dies away and speculative interest unwinds.