All Trade Ideas and trading scenarios found on FX360.com are hypothetical. FX360.com has not placed these Ideas in a live trading environment. Forex Trading involves high risks, with the potential for substantial losses that exceed your initial deposit and is not suitable for all persons. Past performance is not necessarily indicative of futures results.

2012 Gold Outlook

Last updated 1/2/2012 11:44 AM ET (GMT -5) 0 Comments - Add your comment

• Share this:

Boris Schlossberg

Director of Currency Research, GFT

@import url(/css/cuteeditor.css);

Looking Back

Given gold& #8217;s recent lethargy, it’s easy to forget just how well it has performed over the last twelve months. At the time of this writing (early December 2011), gold is up around 22% on the year. Compare this to the major global stock indices: The U.S. Dow Jones Industrial Average is up around 4%; the UK FTSE1 00 is down 7%, the German DAX has fallen 14% while the Japanese Nikkei 225 is down 15% and the Shanghai Composite is heading for an 18% loss. Even when looking at other metals, gold has outperformed. Silver is about 3% higher while COMEX copper has fallen around 20% over the last twelve months.

However, 2011 was not all fun and games for gold bulls. Gold began the year struggling to break above $1,400 and fell steadily over January to retest support just above $1,300. Then gold embarked on a strong rally which eventually took it to a fresh all-time high in nominal terms just above $1,900 by the end of August. However, it subsequently dropped 10% over the next three trading sessions. This move corresponded to a general slump across all so-called “risk assets” following the failure of U.S. policymakers to act decisively on extending the country’s debt ceiling. This political impasse triggered a downgrade from ratings agency Standard and Poor’s, whereby the U.S. lost the AAA credit rating which it had held since 1941. Yet, gold recovered quickly and made a fresh intra-day record high in dollar terms in early September. But then, we experienced a second vicious and protracted sell-off, which saw gold lose 20% over the next three weeks. The metal has recovered its poise over the fourth quarter, but there is little doubt that investor confidence has taken a knock and there are now doubts over gold& #8217;s reputation as a safe haven.

Gold in a Bubble?

Many analysts were quick to say that gold was in a bubble that has now popped. Typically, these analysts actively discourage investment in precious metals by saying that because gold doesn’t pay interest or a dividend (and costs money to store in physical form or to hold via futures or ETFs), it is a poor place to park capital. However, in a world where yields are universally low, or come with unacceptable risk, owning gold becomes more attractive. On top of this, the growth in Exchange Traded Funds (ETFs) has allowed the wider public to trade it easily. For many who were unhappy holding physical gold, either because of the storage costs or security risks, ETFs have proved to be a viable alternative.

But die-hard gold bugs (who point to gold& #8217;s universal acceptance as a medium of exchange for thousands of years) say that gold is nowhere close to “bubble territory.” They note that when adjusted for inflation, the previous record high of $850 achieved back in 1980 would price gold at around $2,400 today. Gold bugs also argue that gold is destined to rise much further than this, as central banks continue to print money and inject liquidity into the markets. This is viewed as a desperate measure to combat the debt deleveraging currently taking place. In addition, as every country seems intent on boosting growth by cheapening their currency to encourage exports, this simultaneous devaluation of fiat currencies can only boost gold& #8217;s appeal. Bullish gold investors are quick to point out how gold holds its value and frequently cite the following example: after the Bretton Woods Agreement in 1946, gold was fixed at around $35 per ounce. Back then, an ounce of gold would buy you a decent suit. Flash forward to today, an ounce of gold will still buy you a good suit, but $35 won’t. Which would you rather have held over the last 75 years: $35 or an ounce of gold?

Central Bank Purchases

One of the biggest fundamental drivers for gold& #8217;s recent price rise has been the changing behavior of central banks. For over twenty years, central banks were net sellers of bullion. But in the last couple of years, we have seen significant purchases by China, Russia, India, and Mexico amongst others. We have also seen Venezuela begin to repatriate its physical gold from banks in Europe, the U.S., and Canada. Meanwhile, the central banks of developed economies, which hold significant proportions of their reserves in gold, stopped selling. There are two reasons for this change in behavior. First, in contrast to many developed countries, emerging market central banks typically have only a small percentage of their foreign exchange reserves in gold; they are now in a position and have the will to rebalance their reserves in gold& #8217;s favor. Second, noting the persistent budget deficits that the U.S. is running which threaten the status of the dollar as the world’s reserve currency, there is a wish to diversify out of dollars as well as other fiat currencies.

A Few Thoughts on Silver

Gold and silver are often bundled together these days in the minds of investors. Silver generally moves in the same direction as the yellow metal, but with far greater volatility. Silver has a dual capacity: It is viewed as both an investment and an industrial metal. However, it is rare that these two qualities are considered at the same time. Consequently, when investors are concerned about a slowing global economy, they tend to sell silver and forget about its investment potential. But like gold, silver has acted as a medium of exchange and store of value for thousands of years. There are reasons to believe that investors will rediscover these important properties. In addition, silver tends to get used up in industrial processes and recycling rates are low. This is in stark contrast to gold where the vast majority of gold ever mined still exists above ground. Silver stockpiles have fallen quite dramatically. Estimates suggest that above-ground stockpiles have now fallen to one billion ounces from four billion in 1980.

Looking Forward

As noted previously, gold and to a lesser extent silver have both performed well over the last year. Many investors will be asking themselves if this upward momentum can continue. The drivers for this year are likely to be the same as last: If central banks continue to be net buyers, then gold should find strong support, at least as far as the physical market is concerned. However, the paper (futures and forward) markets dwarf the physical in terms of the outright number of ounces traded each day. Physical buyers tend to be long-term holders who have made the decision to own gold because it offers a method of wealth preservation. It is a store of value and a medium of exchange. It cannot be devalued as it cannot be created by the press of a button as currency and debt instruments can. Therefore, it makes up an important part of any investment portfolio.

Yet, over the short-term, the movements in the gold price correlate closely with those of other “risk assets.” Leveraged investors, such as fund managers and speculators, use the futures market and ETFs. These instruments are typically traded on margin. Consequently, if say equity markets experience a sell-off, there is usually a rush to liquidate all margined positions to raise cash and limit future losses. Both gold and silver have been caught up in these sell-offs before, and it’s probable that they will suffer again. As we have seen this year, the buy-side of the gold trade can get overcrowded; a small piece of negative news can result in a rout and heavy losses for longs, especially if over-leveraged. One thing is for certain − precious metals will remain volatile for as long as economic uncertainty continues to grow.

- David Morrison contributed to this article

The information, including Commentary and Trade Ideas, provided on FX360.com should not be relied upon as a substitute for extensive independent research which should be performed before making your investment decisions. Global Forex Trading and FX360 .com is merely providing this information for your general information. The information and opinions presented do not take into account any particular individual’s investment objectives, financial situation, or needs. All investors should obtain advice based on their unique situation before making any investment decision and should tailor the trade size and leverage of their trading to their personal risk appetite. Any projections or views of the market provided by FX360.com may not prove to be accurate.

The views of the authors and analysts are not necessarily those of Global Forex Trading, its owners, officers, agents or other employees. FX360.com and the currency research team will not be responsible for any losses incurred on investments made by readers and clients as a result of any information contained on FX360.com. Global Forex Trading and the currency research team do not render investment, legal, accounting, tax, or other professional advice. If investment, legal, tax, or other expert assistance is required, the services of a competent professional should be sought.

Loading...

About The Author

Boris Schlossberg began his Wall Street trading career more than 20 years ago at Drexel Burhnam Lambert. There, he traded nearly every type of financial product on the market in the U.S., from equities and options to stock index futures and foreign exchange. His innate ability to analyze market information and use it to trade has helped him become an industry-recognized, “go to” trading professional.

These days, whenever the markets move, many organizations turn to Schlossberg for his take on the situation. He is a weekly contributor to CNBC's Squawk Box and a regular commentator for Bloomberg radio and television. His daily currency research is widely quoted by Reuters, Dow Jones and Agence France Presse newswires and appears in numerous newspapers worldwide. Schlossberg has written for publications like SFO magazine, Active Trader and Technical Analysis of Stocks and Commodities. He is also the author of Technical Analysis of the Currency Market and the co-author of Millionaire Traders: How Everyday People Are Beating Wall Street at Its Own Game with Kathy Lien. He joined GFT in 2008.