GOLD PRICE BUBBLE A " HIGH PROBABILITY" / THE FINANCIAL TIMES ( RECOMMENDED READING )

Gold price bubble a “high probability” says Deutsche Bank

By Chris Flood

Published: January 13 2011 20:01

The formation of a gold price bubble is a “high probability event”, warns Michael Lewis, commodity strategist at Deutsche Bank.


Mr Lewis says that the price of gold would need to rise above the $2,000 an ounce mark to represent a bubble but he notes that the factors that have driven the market higher in recent years are likely to continue in 2011.


Expecting US real (inflation adjusted) interest rates to remain negative, an environment that historically has seen gold (and silver) perform well, Mr Lewis also warns that a collapse of the dollar “cannot be dismissed out of hand” given the significant fiscal consolidation required in the US.


He also expects central banks, particularly in Asia, to diversify their foreign exchange reserves further by increasing their holdings of gold and he says inflows into gold exchange traded funds will continue to increase, reflecting investors’ desire to find protection against the twin threats of deflation or rising inflation.


The value of investors’ holdings in gold exchange traded funds ended 2010 at $98bn, a record, even though last year’s inflows into gold ETFs were substantially lower than in 2009.


Last year’s rise in gold prices helped to increase the value of gold ETF holdings 40.2 per cent from $69.9bn at the end of 2009.


According to Barclays Capital, inflows into gold ETFs were 330 tonnes in 2010, down by almost half compared with 614 tonnes in 2009.


Total gold ETF holdings were 2,140 tonnes at the end of 2010, slightly below the all-time high of 2,155 tonnes reached in the middle of December.


Investment buying (ETFs, coins and bars) has become an increasingly important source of total gold demand, rising from just over 10 per cent in 2000 to an estimated 40 per cent last year.


Suki Cooper, precious metals analyst at Barclays Capital, says that investment demand for gold is likely to slow towards the end of 2011 but it will still be strong enough to push the price to a fresh record high.


Barclays is forecasting that gold will trade this year between a low of $1,300 and a high of $1,620, helped by the growing interest in physically backed ETFs and buying by central banks.


Silver exchange traded funds also saw a slowdown in inflows in 2010, dropping to 2,805 tonnes from 4,112 tonnes in 2009.

At the end of 2010, total holdings in silver ETFs stood at $15,170 tonnes, just slightly below their all time peak of 15,625 tonnes reached in mid-December. With with silver prices ending 2010 at $30.86 an ounce, a twenty-year high, the value of holdings in physically backed silver ETFs concluded the year at a record $15bn.


Ms Cooper notes that the silver market fundamentals remain weaker than the other precious metals as mine supply is running at record levels while photography demand is in structural decline and jewellery consumption remains sensitive to high prices.


This leaves the outlook for the market very dependent on demand from investors and Ms Cooper warns that if their appetite sours, then silver prices are likely to suffer a sharp correction.


Records were also set for platinum and palladium ETFs with both metals seeing substantial increases in investor inflows last year.


Platinum ETF inflows rose from 384,000 ounces in 2009 to 551,000 ounces in 2010, taking total holdings to an all-time high of 1.2m ounces at the end of the year, worth a record $2.2bn.


Ms Cooper says platinum ETP demand is expected to remain “healthy” in 2011, driven by constructive supply and demand fundamentals. However, the year-on-year comparison is likely to suggest a slowdown as there was such a strong response by investors to the launch of a US platunim ETF at the start of 2010 by ETF Securities.


Similarly, palladium ETF inflows doubled from 507,000 ounces in 2009 to 1,038,000 ounces in 2010, taking total holdings to an all-time high of 2.2m ounces at the end of the year, worth a record $1.8bn.


Ms Cooper says inflows into palladium ETFs are likely to slow this year but this will be counterbalanced by smaller sales from Russian state stocks so the balance between supply and demand should be tighter this year.

Copyright The Financial Times Limited 2011.