Gold Losing Its Shine as Supply Surges

April 08, 2009 | By: Sean Maher

The irony is that just about every goldbug was also a convinced dollar bear a year ago, and their emotionally charged analysis has proved utterly misconceived in a deleveraging global economy.

While many observers have concocted elaborate conspiracy theories to explain the relatively disappointing performance of the metal despite economic crisis and the historic Fed money printing initiative, the truth is far more mundane.

Most traditional emerging market importers have seen jewellery demand collapse to the remarkable extent that Turkey, the world's second biggest importer is now a net exporter of bullion scrap, and India, the biggest market, imported no gold in February and March. Economic distress in these countries has not only reduced demand, but created forced sellers. A similar pattern is evident in the Gulf states and across Asia, and the sheer volume of scrap gold now hitting the market far exceeds prospective IMF sales.

So far in 2009, scrap sales may well have exceeded global mine supply, and Asian prices are now at a discount to London rather that the traditional premium. Unless investment demand soars further from these levels, the downward pressure on prices could see gold trading well under $800 by early Summer. In 2008, gold again peaked in the first quarter, but jewellery demand bounced in late summer as prices sank toward the $700 level, but that was in a very different economic environment across the key importing markets.

This year, while the sheer volume of scrap exports is unsustainable, any rebound in demand would require a strong cyclical economic recovery in countries like Turkey and India. But that scenario undermines gold's recent investment role as a safe haven as other assets crumbled. I watch the EUR/JPY cross as a key measure of global risk appetite, and it is now at its best since late October, reflecting the recent rally across risk assets.Crucially, de-hedging by producers will be running at negligible levels in 2009, a function of the much reduced hedge book; there's only marginal interest in strategic hedging by producers.

While I expect inflation to pick up to mid single digits over the next few years in the US despite a very weak and erratic economic recovery, neither a dollar collapse nor hyperinflation are realistic prospects in the foreseeable future; China's bluff has been called in the recent debate about the dollar's role as de facto global reserve currency. However distorting to global investment flows, there is no obvious alternative in terms of liquidity and capital depthand certainly not gold; any commodity linked currency arrangement is essentially deflationary due to arbitrary supply constraints.

Overall, gold investors may be frustrated by another range-bound year, buffeted by the cross-currents of periodic spikes in investment demand set against fundamental demand destruction. There are plenty of other ways to hedge rising inflation in the context of a muted economic recovery and commodities like uranium, platinum and natural gas look more attractive medium-term prospects to me.

Disclosure: No positions

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