Gold bugs fight back

Just when the bears thought they’d finally brought some sense to proceedings, the gold bugs have launched a rear guard assault.

Gold prices have risen strongly in the past six weeks, a lift that has gathered pace this week with a 2.5% jump overnight as the dynamics affecting the precious metal appear to have shifted dramatically.

When Ben Bernanke first let slip on May 22 that the US Federal Reserve would begin tapering its $US85 billion a month injection into the American economy, gold prices crashed, reinforcing a slump that occurred several months earlier.

Inflation was at rock bottom and the prospect of prematurely withdrawing the monetary amphetamines scared the pants off punters who had bet the house on the prospect that such radical monetary stimulus would result in a quantum shift in long term inflation.

Each time tapering was mentioned, gold was hit by an avalanche of selling with George Soros and John Paulson both declaring their bearish intentions.

This week though, talk of tapering has had the opposite effect.  Gold prices have pushed higher, last night bolstered by a largely anticipated lift in the US consumer price index. Gold rose 2.5% as it breached $US1350 an ounce as short sellers have been forced to cover their positions.

The shift in sentiment is not purely driven by inflation perceptions and financial traders and speculators. The physical market dynamics have also shifted on their foundations.

Gold’s sudden drop to $US1200 an ounce hit recyclers, saw minor producers exit and large producers scale back production.

On the demand side, central banks piled in to take advantage of the slump to lift reserves while retail demand soared.

At this stage, gold appears merely to have bounced off a bottom that was overshot by the mad selling precipitated by the prospect of the stimulus withdrawal (see Clifford Bennett's The aggressive play is gold).

But any hint of inflation in the future will lure gold buyers back in force. With Europe only just emerging from recession and hopeful but mixed signals from America, that may be a few years away.