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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Gold Breaks Above Psychological Level of $900 - Short-term Correction Expected

Commodities / Gold & Silver Jan 14, 2008 - 10:21 AM GMT

By: Gold_Investments

Commodities Gold's strong performance continued last week and gold was up $4 to $894.90 per ounce in trading in New York on Friday and silver was up 8 cents to $16.23 per ounce. Gold was thus up 3.5% for the week and silver surged 6% breaking long standing overhead resistance to reach new 27 year highs.


Gold has again risen in Asia and early European trading and the London AM Fix was at a new record high of $911.50 (up from $887.85). The psychological level of $900 has now been attained and a correction and consolidation is likely. However, given the deteriorating economic situation in the U.S. and many economies internationally the safe haven flight to gold we have witnessed in recent weeks could continue and accelerate. Analysts and traders are already looking to the next even bigger psychological level of $1,000 per ounce as a likely price target. This new price target could be reached earlier in 2008 than most have anticipated. Traders and analysts like big round numbers (witness $100 a barrel oil) and thus $1,000 could prove a similar magnet to traders.

Gold surged to new records in other major currencies. At the London AM Fix gold was trading at £464.32 (up from £457.56 Friday) and €612.16 (up from €604.74 Friday). The notion that gold is being bought because it is 'cheaper' to holders of other currencies is a missapprehension and is wrong. Gold is surging in all currencies and this shows that gold's strength is not primarily a function of dollar weakness. All major currencies are weakening against gold. In the last 5 years, the euro is only up some 40% against the dollar whereas gold is up by more than 150% against the dollar. Or to put it more accurately the dollar is down by 40% against the euro but the dollar is down by some 150% against gold. Since 1999, gold has risen by some 140% in euro terms - from €250 to over €600 today. Since 2001, gold has risen some 170% in british pound terms - from £170 to £464 today.

Expectations that the Federal Reserve will aggressively cut interest rates despite inflationary pressures will likely support gold and result in any correction being short and shallow.

The Week Ahead
A 0.50% cut at the next meeting is now expected and with the ECB continuing to make hawkish sounds the dollar looks set to continue to weaken. There is a raft of important data this week with PPI, CPI and retail sales for December. Key housing markets reports are also scheduled and are expected to show deteriorating conditions in this sector. Latest industrial production figures are released and perhaps the most important data may be the net capital inflows reports. Also, there is important quarterly results in the U.S. and there is likely to be news of further fallout from the credit crisis with rumours that Citigroup alone may be about to announce another $24 billion in writedowns.

Large Capital Flows into Commodities to Continue
These inflationary pressures are leading to retail, institutional and pension fund investment in commodities. This diversification into commodities is expected to continue in 2008 and in the next few years as the very small allocations to commodities are increased. Globally only some $110 billion to $130 billion is vested in assets tracking commodities and many funds have less than some 1% to 2% vested in commodities. Some have no allocation whatsover to commodities and it is estimated that some $1 in every $1,000 of international investment capital is invested in commodities or some 0.1%.

Calpers, the largest U.S. public pension fund, said last month that they are widening their asset allocation for its $250 billion portfolio and will invest more money in inflation linked assets such as commodities. Ruth Sullivan in the FT reports that Calpers is devoting $13 billion or 5% of its portfolio into the category. ABP, the large Dutch pension fund, which was one of the first Dutch pension funds to invest in commodities in 2001, has increased its allocation in commodities from 2.5% to 3% in its strategic investment plan for 2007-2009. ABP like commodities because "they are a good diversifier in a portfolio" and "comparable to other asset classes, tend to have a relatively high correlation with inflation, which is beneficial for a pension fund with indexed liabilities such as ABP."

Support and Resistance
While gold's fundamentals remain very sound in the medium to long term, in the short term we may be overbought and thus we could experience a healthy short term correction. Support is at previous resistance at around $840 to $850, below that at the 50-day moving average at around $820. However, traders and investors would be wise to continue to 'make the trend their friend'. Especially in the current macroeconomic and geopolitical climate.

Markets had anticipated $900 per ounce and now analysts are looking forward to the $1,000. There may well be a short term correction however $1,000 now seems more likely in the first half of 2008 than in the second half.

FX
The combination of a hawkish ECB and a dovish Federal Reserve help lift the euro back above 1.4900 since last week. Traders will now start to eye the November 23rd all time high for the single currency against the greenback of 1.4965. Current momentum suggests that a breach the psychological level of 1.5000 is imminent. However, it is not just against the U.S., dollar that the Euro is appreciating, as new lifetime highs have been set against sterling too. At the time of writing the Euro is trading against the Pound at just below 0.7600 and now opens up an intermediate target of 0.7700.
While the Euro has remained relatively strong against the Japanese yen, both the U.S. dollar and sterling have weakened considerably against yen. This is driven by the mounting negative economic sentiment for both economies and the resulting outlook for interest rates. The carry trades which have been popular over the past number of years saw investors borrowing currencies with low interest rates (yen and Swiss francs) and investing in assets in higher yielding currencies. As the interest rate differential now looks to narrow and volatility increases a large proportion of these “carry trades” will have to be unwound, ultimately resulting in further yen and Swiss franc appreciation against the U.S. dollar, sterling and the euro.

Silver
Silver has continued to surge and rallied to $16.49/16.51 at 1130 GMT. Silver is now in unchartered territory from a technical point of view. Technicians will look to the nominal high in 1980 at $50 per ounce as a possible long term price target. Given the extremely strong supply/demand fundamentals in silver we continue to believe that silver will likely outperform every other commodity and outperform gold and the other precious metals - http://www.gold.ie/Articles_of _Interest/AOI_08-05-07_Why_the _Silver_Price_Is_Set_to_Soar .htm .

PGMs
Platinum was trading at $1585/1590 as per above (1130 GMT).
Palladium was trading at $380/385 an ounce (1130 GMT).

Oil
Oil is largely flat in European trading and NYMEX light sweet crude oil (FEB08) was trading at $92.71 a barrel.

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