Gold: Hot in Q3, Not in Q4?

by James Brumley | September 27, 2012 1:44 pm

[1]To say that gold surprised folks in the third quarter would be an understatement.

Back in the second quarter, gold tumbled 4.2%, topping off what ended up being a 15.9% pullback from the September 2011 peak. Even scarier was the fact that gold was knocking on the door of a new 52-week low.

But did gold go through that brewing meltdown? Nope — not even close.

What’s Going On?

Instead, gold posted a 9.5% gain in the third quarter this year, while inflation could very well keep driving the commodity up. And the prompt for gold’s Q3 rally is obvious: A wave of stimulation effort from the world’s financial superpowers[2]: Europe, the United States, Japan and China.

Well … kind of. There’s just one problem with that “obvious” conclusion: It’s not right.

Or at least, it’s not wholly right.

While stimulus announcements have been expected for a while, they didn’t materialize until the beginning of September. Gold’s third-quarter rally began right at the beginning of the quarter. So, stimulus and its potential inflationary effects can’t get all the credit.

How about unstimulated inflation? Wrong again — we haven’t seen significant inflation for any reason since the rate peaked at 3.87% in September of last year. As of August’s data, the current inflation rate stands at 1.69%, so deflation might be a bigger concern than inflation at this point.

Plus, considering the amount of liquidity that’s been injected into the global economy since 2009, inflation has never gotten anywhere near its worst-feared levels. So, why would it this time around?

The next possibility is demand for physical gold, which might be on the mend to some degree: China and India — two of the biggest gold buyers — have restarted their buying efforts following a drastic Q2 decline.

But the rekindled demand still doesn’t jive with the steep ascension in gold prices. In other words, current demand for physical gold in Asia still pales in comparison to the demand seen through Q1 of this year.

What’s Really Going On

So what’s driving gold higher right now? Mostly, it’s the demise of the U.S. dollar.

It’s a multi-pronged mess to be sure, but gold prices are affected by an ever-changing mix of investor and speculative demand, inflationary fears, physical demand and the currency it’s priced in (U.S. dollars).

And yes, those four factors influencing the price of gold can also influence one another, making gold a constantly moving target. (For that reason, never believe anyone who says they have a bead on the underlying fundamentals of gold. There is no consistent pricing model.) But right now, the biggest driver is the U.S. dollar. It has been falling, so gold has been rising.

This raises two obvious follow-up questions: What’s causing the dollar to sink, and when might it stop?

The Sinking Dollar

gold dollar
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It’s probably surprising for most that U.S. currency has been weakening relative to its key trade partners like Europe, Japan and China. As lethargic as the economy might seem here, it’s worse in the EU. Meanwhile, both China and Japan have made an ongoing point of keeping their currencies weak compared to the greenback, primarily to drive exports of their good into hands of U.S. consumers.

By late July, though, those factors that had been driving the dollar upward reversed course, letting the dollar tumble and letting gold subsequently rally.

As for the actual reason for the run-up and then run-down, it’s mostly a mistimed anticipation of when the stimulus would be unveiled. The market — individual and instructional traders alike — began betting on a stimulus in late July, and ran gold up and up until they got that stimulus in spades by mid-September.

By that time, however, they had overshot.

Gold’s Outlook

So when might the greenback’s bleeding stop? It’s possibly it already has. The dollar has been back in rally mode since the mid-month, and gold has suffered a commensurate dip. Still, it’s much too soon to say the sawbuck’s worst days for a while are now behind it.

On the flip side, though, all big trends start as small ones.

So what’s the outlook for the metal? Well, gold might well be on its way to prices above $2,000. It’s not going to get there in a straight line, however.

The commodity is overbought right now, and due for a dip that will burn that overbought pressure off. Throw in the fact that physical demand has yet to fully recover, along with the fact that the “gold-mania” trade has lost some of its novelty, and what you have is a rally that’s apt to lack follow-through.

And, all joking aside, the fact that so many experts and amateurs alike are certain gold is riding a rocket to record-breaking prices[3] is a good reason to actually think the opposite. These guys (and gals) were saying the same kind of thing in August of last year, November of last year and in February of this year.

  1. [Image]:
  2. A wave of stimulation effort from the world’s financial superpowers:
  3. are certain gold is riding a rocket to record-breaking prices:

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