BMO COMMODITY COMMENT - Gold only tarnished on the outside and will regain ground in the year ahead

While the surging dollar, U.S. regulators, and hedge fund woes have derailed gold, BMO Capital Markets’ Bart Melek asserts gold is “only tarnished on the outside,” and that the metal will regain ground in 2008-09.
Author: Dorothy Kosich
Posted: Tuesday , 16 Sep 2008

RENO, NV -

In a "Commodity Comment" released the Monday that Wall Street experienced its worst day in seven years, BMO Capital Markets suggested "that the gold market may be oversold, but it is not clear if a rally is imminent given the current financial and foreign exchange environment."

BMO Global Commodity Strategist Bart Melek summed it up succinctly: "Things are not ‘adding up', i.e. markets are not behaving in a consistent manner."

Despite the turmoil, Melek advised that gold will regain its ground into 2009.

"Negative interest rates and systemic risks in the financial sector, the credit crunch are all making many fixed income assets, equities, and real estate a risky proposition," he said. "As such, investors could well start building their gold positions again given other asset classes have lots of risk associated with them and only limited upside."

In his analysis, Melek blamed "interference from U.S. regulators and anti-market speech-making coming from legislators of every political stripe" for "sapping investor interest away from commodities."

Noting the SEC had issued a temporary order in July restricting the short-selling of the shares of 19 firms deemed important to the financial system, Melek asserted that "This in turn greatly reduced the ‘short financials/long commodities trade,' hitting gold and oil particularly hard, while the dollar-driven crude selloff also helped to feed back negatively into gold. The muting of ‘inflation psychology' caused by lower energy prices reduced the impetus to buy gold."

Nonetheless, Melek forecast that "BMO expects gold to regain its ground into 2009."

Gold will regain its luster, he asserted. First, the U.S. economy is in recession mode and the rest of the G7 are not doing much better, making the equity market outlook uncertain. Negative interest rates and systemic risks in the banking system are making fixed income assets and real estate a risky proposition, he added,

"As such, investors could well start building their gold positions again given other asset classes have considerable risk associated with them and only limited upside," Melek suggested. Meanwhile, low U.S. interest rates and few investment opportunities well into 2009 should keep the opportunity costs for holding gold fairly low, he explained. "Gold remains cheap relative to both gold and equities by historic norms."

High oil prices would also "go a long way to reignite investor interest in buying gold as an inflation hedge again, especially once the G7 economies recover," Melek said.

He observed that the physical demand for gold has picked up strongly since the gold price dropped below $800, adding that jewelry and fabrication demand "should help boost bullion."

"August gold imports into India, the world's biggest consumer of gold, have already risen 45% year over year to about 100 metric tons (about 2.5% of global annual demand)-a trend that may continue for much of 2008," Melek advised.

"Furthermore, BMO analysis shows that gold prices benefit from seasonality, traditionally strengthening some 7% from September to February over the last decade, a direct result of the Indian wedding and festival period in up years."

Meanwhile, Melek suggested that the greenback will remain weak in trade-weighted terms in order to reverse substantial global trade and current account imbalances with China and the Middle East, resulting in good news for the gold price.

"Also quite supportive of the longer-term gold outlook are expectations of rising wealth in India, China, the Middle East and the rest of the developing world-traditional buyers of the metal," Melek advised. Jewellery sales and the use of gold and other precious metals as a story of wealth in these regions are expected to become increasingly important sources of physical demand."

"As such, the metal may even de-link from the euro and trade based on the value of the Chinese and Indian currency," he suggested.

Melek asserted that "physical buying in the developing world and possibly less central bank appetite for dollars are additional positives for gold."

BMO speculates that some OPEC nations, Russian and China are likely candidates who may want to slow the speed at which they build their dollar holdings, "perhaps even beefing up their gold positions at the same time. Of course, if this were to happen the yellow metal would surge."