It is a matter of time before gold moves higher

While gold is being met with strong resistance on approach of $1,285, we believe it is a matter of time before gold moves higher. There is current resistance from the gold physical market to gold’s quick move from $1,250 to $1,280. The resistance from the physical market (with scrap also coming to the market), may see gold consolidating in the $1,270—$1,280 range for a while.

Ultimately we see gold heading towards our target of $1,300 within the coming weeks. We believe, should gold breach $1,300, the metal could rally higher towards $1,320 on the back of technical buying.

Gold support is at $1,270 and $1,265. Resistance is at $1,285 and $1,295.

Expect demand to return should gold settle in a range for a few days

Gold is still pushing higher on good support this morning, as US treasury yields remain around the 2.75% level and implied real interest rates below 1%. The futures market also expects the Fed funds rate to remain low, well into 2011. The futures market puts the probability of an unchanged Fed Funds rate by Aug'11 at 66%. One month ago the futures market assigned a
probability of 54.6% to unchanged rates until Aug'11. Two months ago this probability was only seen as 25.4%.

Markets expectations of a rate increase are constantly pushed further into the future. This has happened consistently since the start of 2009 and we believe it will happen again. Low interest rates are bullish for gold. With the latest push in gold, physical demand has dried up. This pattern has repeated itself in the past, with demand falling away when the gold price rises fast. However, we expect demand to return should gold settle in a range for a few days.

Gold support is at $1,265 and $1,260. Resistance is at $1,285 and $1,300.

Gold pushing towards USD 1,300 per oz

We’ve held the view that gold would breach $1,300 in Q4:10 since May (see Commodities Daily of 12 May and Commodities Insight of 11 Aug’10). At that time, our view was based on investment demand and an expectation that physical gold demand would pick up in Q4:10. Since August, gold demand from the physical market has been rising as seasonal jewellery demand picked up.

Apart from rising global liquidity and low real interest rates, one of the main factors driving our view for gold, and the timing thereof, has always been the behavior in the physical gold market. When the gold price hit new highs on 21 June, resistance from the physical market was strong. Refer to our Standard Bank Gold Physical Flow Index (GFPI) in the adjacent figure. Our index tracks physical flows in the gold market. An index value greater than zero confirms buying activity in the physical market; the higher the value, the greater the buying momentum. An index value less than zero confirms selling in the physical market.

Between April and July, physical demand was low and gold selling (including scrap) high. Now however, with seasonal demand picking up, buying interest is much stronger, and this is supporting higher prices rather than offering resistance. We expect physical
demand to remain strong in Q4. Apart from strong physical demand for gold, we believe that other macroeconomic factors have become more positive for gold. 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.

The yield on the 10-year US inflation linked bond is well below 1%, implying that the market expects real interest rates to average a mere 1% over the next 10 years. Back in June, the same yield traded around 1.3%. A lower implied real yield favours gold investment.

We maintain our view that gold will breach $1,300 in Q4;10.

Gold continues to find support on price dips towards $1,240

Gold continues to find support on price dips towards $1,240. Our view remains unchanged - dips are likely to be bought on the back of increased seasonal demand, low real interest rates and continued growth of global liquidity. After a slight pull-back in physical demand when gold moved towards $1,260 last week (and even some scrap selling), physical demand is positive
again and we believe supporting the metal.

Gold support is at $1,240 and $1,237. Resistance is at $1,254 and $1,260.

Short-term gold may find resistance to a move higher

Despite positive real economic news, especially out of China over the weekend, we maintain gold will push higher in Q4:10.

While the 10-year government bond yield in the US continues to move higher (from very low levels), the yield on the US inflation-linked government bond remains almost unchanged at around 1%, showing that the market expects real interest rates to remain low in the US. Low real interest rates are bullish gold.

The latest CFTC data indicates speculative interest is rising in precious metals. We noted in the Focus section that gold’s net speculative position is in line with the average level seen over the past two years when looking at the speculative length as a percentage of open interest (OI). Platinum doesn’t look overextended using this measure (although silver and palladium’s net
speculative positions are starting to look very high):

• NYMEX Platinum’s net speculative length stands at 50% of OI, well below the highs of around 64% registered in May this year, and in line with the average of 49% over the past two years.
• NYMEX Palladium’s net speculative length stands at 65% of OI. Palladium’s speculative length as percent of OI has not come down substantially since May and has hovered around these levels since the start of the year.
• COMEX silver’s net speculative length stands at 28% of OI, well above the average of 21% of OI seen over the past 2 years. This is also not far off the highs of 30.8% reached in September last year.

However, as with gold we continue to see good physical demand for silver from both India and Asia. Short-term gold may find resistance to a move higher, especially on the back of positive data from China over the weekend. We see gold support at $1,242 and $1,240, with resistance at $1,260 and $1,265. We expect physical demand to provide additional support at the $1,230—$1,235 level.

In the long-run a low real interest rate is bullish, especially for gold

Investor look to developments in the US bond market — the US 10-year government bond (UST) yield appears to have broken out of the downward channel it has traded in since the start of April. Currently the 10y UST yield is at 2.75%.

We also look at the US 10y inflation-linked bond (TII) yield which has remained almost unchanged at 1% over the past few weeks, indicating the market expects US real yields to remain low for a long time. In the long-run a low real interest rate is bullish, especially for gold.
A rising nominal real yield (from the 10y UST) and a constant real yield (from the 10y TII) implies higher inflation expectations (breakeven inflation) in the US. Current breakeven inflation in the US is still low, but it has reversed it’s downwards trend and currently stands at 1.75% (after bottoming at 1.45% mid-August).

This is important for precious metals, not necessarily because we expect inflation to run rampant and push precious metal prices higher, but it signals a move away from deflation fears. A world where debt is an issue, falling prices will only amplify the problem.

At the moment gold is finding strong resistance at $1,260 level. This may well continue for now. We expect physical demand to remain strong on price dips. As a result we expect gold to find support on pull-backs of $10—$15. We continue to see the yellow metal heading towards $1,300 in Q4:10. Gold support is at $1,251 and $1,247. Resistance is at $1,260 and $1,265.

European debt is at the forefront once again

Gold is pushing towards its all time highs of $1,265. Our target for gold remains $1,300 in Q4:10.
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 (refer to Commodities Insight dated 11 Aug’10).

Global liquidity is ample and real interest rates are low; as a result, investment demand for gold is likely to remain in place. Gold’s relationship with liquidity is confirmed visually (refer to figure) 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 13% YTD. As ETFs are utilised by institutional and retail investors, they are an important vehicle for liquidity and low interest rates to be channelled into gold demand. Given robust global liquidity, it is not surprising that total ETF holdings now stand at around 2,030 tonnes. Since the start of 2009, gold ETF holdings have increased by almost 72%. In the past two years, ETFs have executed few liquidations despite increased market volatility.

The relationship between global liquidity and commodities indicates that gold is a main beneficiary. In fact, gold has been tracking global liquidity. We expect the Fed to keep interest rates unchanged for most of 2011 and, thereafter, to hike rates slowly. The 10-year US inflation-linked bond yield is around 1%, indicating that the market expects real interest rates to average a mere 1% over the next 10 years. The current yield is well below that of 1997, when the real interest rate implied by inflation-linked bonds was at 4%. The current yield favours gold investment.

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. However, until either real interest rates start to rise or liquidity declines, we believe that gold’s investment case remains intact.