Gold’s fate linked to dollar movement

Even 2008 draws to a close, it is becoming increasingly clear that all commodities market participants - traders, investors and others – will remember the year for the extraordinary price performance, gyrations and volatility. Commodity prices - be they of energy, metals or agriculture - not only hit multi-year record highs at one time, but they also plunged to great depths in a matter of weeks, if not days, precipitating a crisis.

Quite contrary to the first two quarters, in the last quarter, producers, consumers, traders and investors faced daunting challenges in the wake of sharply declining demand, rising inventory and collapsing prices.

Speculators exited the market in a hurry, removing a considerable amount of speculative froth that had developed in many commodities during the bull-run.

What started as global slowdown degenerated into a recession, at least in industrial economies such as the US and the Eurozone. Financial and economic conditions have turned grim. Currency fluctuations, especially that of the dollar, impacted market prices.

There is a widespread expectation that notwithstanding continuing recessionary conditions, commodity prices may largely be bottoming out. From the current levels, further downside risk to prices - crude, base metals, agriculture - seems to be limited. The crisis of confidence continues and may stay for some time.

However, when the process of economic recovery begins, hopefully in the third quarter of 2009 as a result of a series of bailout and stimulus packages, investor confidence may return to the market. Until then of course one must reckon with volatility.

There is also the strong possibility that sizeable output cuts that have been made in crude, steel, copper, aluminium and others will store problems for the future and begin to create a supply bottleneck when demand returns.

However, for the time being cash is still king and poor demand outlook remains the top of market concerns.

With the dollar rapidly weakening against the euro last week, gold prices got a boost and decisively moved above $800 an ounce. Physical demand at lower levels amid less volatile conditions generated support.

On Friday, in the London spot market gold PM Fix was at $835.75/oz, down from the previous days $855.25/oz. Silver declined too to $10.61/oz (AM Fix) from $11.29/oz the previous days.

Going forward, the yellow metal will be clearly influenced by the strength or weakness of the greenback. If the dollar should weaken further, it should provide a strong base for the metal to move higher. However, foreign exchange experts are of the opinion that currency movements in the next few weeks may cushion gold’s upside.

Interestingly, as the prices ruled above $800/oz, many investors exited their long positions on the Comex. No wonder, net fund length is near the lows of June 2007.

According to technical analysts, gold’s uptrend is erratic. It may be tough for the metal to breach $880 levels. The market is holding above short-term support of $829. Below $829 would warn of a deeper pullback towards $782, though even in this scenario the choppy uptrend from October lows is likely to remain dominant force. The medium term view is largely neutral within $700-930.
Base metals

After sliding to fresh lows, base metals prices rallied on news that the US government will give an emergency loan of $17 billion to the US car manufacturers. Other wise, it was terrible week for base metals, with the exception of aluminium and zinc which ended the week higher. Lead prices fell by over 16 per cent week-on-week and tin fell by over 10 per cent.

Outlook for the base metals complex over 2-3 quarters into next year is grim with recessionary conditions and lack of demand growth the main theme. Construction sector and automobile sector, two important metals consuming sectors are facing serious downturn in demand. Inventories are rising. Many producers have responded quickly with output cuts.

Copper is the metal with the largest downside potential from current levels. Copper prices are is still above production costs and miners are still making money. So, there could be further cost-related cutbacks, experts assert.

On the other hand, aluminium, nickel and zinc prices have all fallen very close to weighted average production costs, experts point out, adding copper could dip near to this level at $2,100 a tonne.

Notwithstanding short-term weakness, the longer term outlook for base metals appears positive. This is because not only is output being cut, new investments are being put on hold. This will squeeze supplies when demand returns to the market. There will be supply constraints with concomitant impact on market prices.

Despite announcement of OPEC production cut and drastic decisions in the US monetary policy, crude prices dipped below the psychological $40 a barrel. Demand side concerns have been top of the markets mind. There are as yet no signs of demand revival. The financial crisis and growth concerns may continue for longer time than imagined earlier.

Experts, however, believe, from the current levels, the downside risk to crude prices is limited. Indeed, they are talking about the possibility of over-tightening of the market in the medium term. The supply performance of non-OPEC sources is being closely watched.

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