Gold Supply Could Restrain Prices—HSBC

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". . .the poor jewelry market could actually pose a threat to prices."

The dramatic run-up in gold prices over the last few years is entirely due to investment demand, which has more than made up for weak jewelry demand. But according to Jim Steel, chief commodities analyst at HSBC Securities, the poor jewelry market could actually pose a threat to prices.

In his latest precious metals outlook, Mr. Steel wrote that U.S. dollar weakness and inflation concerns are providing plenty of price support for gold.

Mr. Steel wrote: "Repeated guarantees from Fed officials that, at the appropriate juncture, the central bank will reverse easing policies and thus head off a potential price spiral have, so far, failed to assuage inflation fears."

He also noted that mine supply remains sluggish and reduced sector sales are curtailing supply. It all sounds bullish for gold.

But Mr. Steel is not convinced. He believes a surge in recycled gold scrap and poor jewelry demand is freeing up plenty of gold for investors and threatens to restrain rallies. He noted that demand for jewelry is down by double-digit percentages around the world, including key markets like India, as people deal with higher prices and lower disposable incomes. Those same factors are behind the record levels of scrap that are hitting the market this year.

"In our view," he wrote, "gold prices will be determined by the interplay of inflation hedging and, to a lesser extent, safe haven buying on the one hand, and weak fabrication demand and the abundance of scrap supplies on the other."

Despite his cautionary words (which are certain to rile the gold bugs), Mr. Steel boosted his gold price forecasts. He is now calling for an average price of $925 an ounce in 2009 (up from his prior forecast of $875), rising to $950 an ounce in 2010. His long-term forecast is $750 an ounce.

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