Has QE3 fatigue set in to the gold market?


"The current nervousness and fatigue among gold investors is understandable, but for both UBS and Standard Bank, there are reasons to still be bullish."

After eight weeks of consecutive increases, gold's net speculative length fell last week. A decline, Standard Bank attributes to "Investor uncertainty over the ability of QE3 to support prices and/or the longevity of Fed's open-ended commitment to easing."

Indeed, the bank wrote in yesterday's daily commodities note that this uncertainty is "weighing on gold", adding that it expects this week's data from the CFTC to show further weakening, although, it cautioned, "we should see some stability as the gold price moves towards $1,700."

While the bank believes that the $1,700 level should hold, it says there is likely to be resistance to higher prices between $1,741 and $1,756.

"We were not keen buyers of gold at $1,780; however, we would be at $1,700. At $1,780, we estimated that gold was pricing in too much QE already, even when compared to its behaviour during previous rounds of easing by the Fed. Should gold drop to $1,700, it would likely reflect only two months of QE from the Fed - a level we deem reasonable," the bank writes in a commodities strategy note out on Friday.

But, it adds, "the fact that the gold physical market in Asia has improved markedly from three weeks ago provides us with some comfort that there could be better support for gold going forward."

It does not believe that the physical market will push prices higher, in fact, buying interest remains historically weak for this time of year but, it says, prices closer to the $1,700 level might entice "much greater buying from the physical market".

In its latest daily commodities note, UBS's Edel Tully writes that within the gold market, nervousness and fatigue among investors is understandable "especially after gold's tamer-than-expected response to QE3 and the generally weak price action after a poor attempt to reach the key $1800 mark in early October."

Gold's performance of late, UBS writes has been a function of it having to compete with other assets for funds post QE3. Indeed, it writes, "It makes perfect sense that gold would outperform other risk assets in anticipation of QE, but underperform during the aftermath...On the surface, a global economic recovery would offer downside risks for gold prices inasmuch as the potential for policy normalisation starts creeping into market expectations."

But, while both UBS and Standard Bank are not surprised that gold has been performing poorly this month, neither is bearish on the metal.

UBS says that while there is indeed a possibility of a faster pace for economic growth, the improvement is unlikely to be considered fast enough to warrant policy normalisation just yet.

"Our economists believe that global growth, production and trade are bottoming out, but they also expect economic activity going forward to be restrained by a combination of de-leveraging in developed markets, decelerating growth in some emerging markets, and overall policy uncertainty."

Adding that, such an outcome reinforces the view that the current accommodative environment is likely to remain in place. "Further, the market appears to be underestimating the benefits of QE3 on gold and the Fed's overall easing bias, particularly the potential for QE4 to replace 'Operation Twist' when the latter expires at the end of the year."

The second reason UBS remains bullish on the yellow metal is its strong positive correlation with risk.

This correlation means that "an improvement in risk appetite on the back of the tentative turnaround in global economic data would in fact benefit the metal."

As Tully points out, "There are two stories at play here - a short-term case of frustrated investors, disappointed that gold hasn't rewarded them with a +$1800 price tag, but against this is another player, with a more strategic view who is either 1) not willing to sell into current weakness and/or 2) using the pullback to add to length. The tug-of-war between the latter and the former in the short term probably means some more downside, but ultimately higher gold prices are only a matter of time away."

Geoff Candy

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