Gold bounce hard to read

Gold was the big winner last night from the threatened US debt default.

But a $US40 an ounce (3%) bounce in the price to $US1,320/oz is likely to be more about short-sellers covering their exposed positions than the start of a long-term rise. Indeed, by this afternoon, the gold price had started to drift lower again.

The rush back into gold was led by investors forced to cover short positions amid fresh speculation that monetary stimulus activities by the US central bank will continue well into next year which will, in turn, put downward pressure on the US dollar.

Indications that there is a US dollar/gold swap underway can be seen in the Australian dollar exchange rate, which rose above US96c overnight and is said by some analysts to be heading back to parity with the US dollar.

The debt stand-off in the US has compounded concern about the strength of the US economic recovery, damaging business confidence and trimming the investment plans of companies and potential home-buyers in the important US residential construction sector.

An extension of central bank monetary stimulus means that interest rates in the US will remain at crisis-level lows, encouraging investors to keep part of their assets in gold where it cannot be manipulated by changes to government policies – or debt defaults.

The question is whether last night’s gold price bounce will be a brief recovery before a resumption of the long-term decline, which has seen the gold price retreat from its all-time high of $US1,920/oz two years ago to its current level around $US1,317/oz.

Gold price spike

Click to enlarge

Source: Bloomberg

The short-term effect of the political crisis in the US is likely to continue for at least three months given the likely repeat budget and debt ceiling stand-off in February.

In effect, gold will reclaim its role as the ultimate safe haven as the US is threatened with more credit-rating downgrades, and the potential for the next political crisis to deliver the previously unthinkable, a debt default.

China’s Dagong credit-rating agency yesterday joined its US rival, Fitch, in warning of a downgrade of US debt, adding pressure on the US dollar.

While political, budget and debt uncertainty remains a live issue in the US, and the US central bank continue to pump cheap money into the system, gold will attract support.

For some of the world’s leading investment banks, including Credit Suisse and Goldman Sachs, the return of gold as a safe haven will have put pressure on clients who acted on suggestions that short-selling gold was the investment world’s best trade for the next one to two months.

It is likely that a big sale of 2 million ounces of gold last week was a short-selling test of the market, which initially proved successful and drove the gold price down to around $US1,270/oz.

Rapid unwinding of that position, and a rush for the exits by other short-sellers, resulted in last night’s $US40/oz gold price recovery.

Volatility like that will be the major feature of the gold market for at least the next few months as the US tries to find a way out of its political impasse.

But, behind the short-term pressures there is a long-term downward trend in the gold price which is likely to return whenever there are signs of stability.

Before last night’s dramatic short-covering pushed the gold price sharply higher there had been minimal reaction from gold to the US debt crisis.

Perhaps it was short-selling pressure which suppressed any reaction to the threat of default but two years ago a similar set of circumstances helped gold rise to its all-time high of $US1,920/oz.

For investors with an appetite for risk, there is probably no better place over the next few months than gold.

In the short-term there will be extreme volatility as the threat of default hangs over the US and its currency.

In the long term, downward pressure remains in place as the global economy continues to recover, investment returns from conventional assets such as equities become increasingly attractive, and interest rates move off their ultra-low settings.