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[Tor]

I got this today. Capital economics......... Gold price to drop to $550 • In the light of gold’s recent lacklustre performance we have lowered our price target from $700 to $550/oz. We expect this target to be reached in the first quarter of next year, if not sooner. • Regular readers will be familiar with our relatively bearish views on gold. As early as March, when gold was still at record highs above $1000, we predicted that prices would be back at $700 within a year. (See our Global Markets Update, “Gold price to fall to $700”, 20th March.) We have restated that target on many occasions, most recently in our Global Markets Focus “Commodity prices have much further to fall”, published when gold was still at $870 (7th October). Gold is currently trading around $750/oz. • Gold is often described as the ultimate safe haven and store of value, and prices have certainly benefited from the turmoil in financial markets over the last year. In particular, gold jumped from around $750 to $900 in little more than a week following the bankruptcy of Lehman Brothers in September. However, prices have also fallen back just as sharply when general market conditions have improved or – as in recent days – when the dollar has surged. This price volatility may be attractive to day traders but it does not recommend gold as a core holding. • Of course, gold has not done as badly as equities this year. In dollar terms, gold prices have fallen by around 11% so far in 2008, compared to a 37% decline in the S&P 500. However, gold is not the only safe haven. Gold has under-performed government bonds, which have delivered a positive return of around 5% over this period. What’s more, many retail investors might prefer to take advantage of the high interest rates now available on government–guaranteed bank deposits. These have none of the currency risk and volatility associated with gold. • Gold bugs also like to emphasise that prices are still higher than they were at the start of the credit crisis (gold was trading at around $650 in August 2007). Even after the recent falls the gold price has more than doubled over the last five years. Investors with long enough horizons are therefore still sitting on decent returns. However, past performance is not necessarily a good guide to the future. If anything, the fact that gold prices remain relatively high might just mean that they still have a long way to fall. After all, the same could be said of any asset bubble that has only recently burst. • Finally, gold bugs like to talk up the strength of retail demand for physical gold. In fact the evidence in support of this is patchy and anecdotal. But assuming demand is indeed already at “unprecedented levels”, the failure of prices to respond more positively simply underlines the downside risks if and when demand weakens again – perhaps because equities are finally too cheap to ignore. • In the meantime, three (related) factors are likely to combine to drive gold prices down further. The first is the continued weakness of other commodity prices. Gold is clearly different from other commodities like oil or pork bellies (and not always in a positive sense: almost all the gold ever mined is still available as potential supply to depress prices further). But the prices of all commodities are now more closely correlated due to the presence of gold in the major commodity indices, where investment funds are now aggressively deleveraging. In addition, lower energy and transport costs will reduce the cost of mining and extracting new gold. • Demand for gold as an inflation hedge will also evaporate as headline inflation rates plummet in the coming year. Worries about the inflationary impact of “printing money” to finance increased budget deficits are exaggerated. With real economic activity weak, unemployment rising, commodity prices collapsing and private bank credit stagnant, by far the greater risk is deflation. • The third negative for gold is the rebound in the dollar. We have consistently argued that gold is best analysed primarily as a currency rather than just another commodity – it is no coincidence that the gold price began to fall in March when the dollar finally stabilised. We expect the dollar to strengthen further to around $1.20 against the euro and $1.50 against sterling in the coming months. Julian Jessop Chief International Economist (+44 (0)20 7808 4996, julian.jessop@capitaleconomics.com)