`There's no bubble in gold,’ CIBC says

Posted by Tracy Alloway on Dec 18 08:46.

The idea of a `gold bubble’ went stratospheric in recent days, as economist Nouriel Roubini blasted the “barbarous relic” and the gold bugs who followed it.

And indeed, on Thursday it seemed Roubini was somewhat vindicated, as the shiny stuff dropped below $1,110 for the first time since early November.

But there are (clearly) those who disagree with the gold bubble theory.

Wading into the debate on Friday, for instance, are the commodities analysts at Canadian bank CIBC, with a research note titled “Bubble, bubble, are we in trouble?” The subtitle, for those who can’t bear the suspense, is “Precious metals to continue their Royal Ascent”.

And the reasoning:

Gold has been exhibiting significant correlation to the U.S. dollar, yet we believe other fundamentals will support continued strong performance of the metal, including stronger investment demand, the market’s need for a safe haven investment, and the absence of growing mine supply.

. . .

The rationale for accelerated reactions to dollar-led gold price movement lies in the additional factors contributing to the strength in the metal. Currency movements may be important but they are not the only factor propelling the price of gold. Uncertainty of many factors has led to strong investment demand for the metal as one of the prime drivers to gold price increases. Whereas jewelry demand accounted for about 82% of metal purchases a decade ago, that figure has dropped with investment demand rising to as much as 73% of total demand in some recent quarters. Aside from the safety protection offered by bullion, we suspect that investors have sought to limit volatility within their holdings by diversification into traditionally counter cyclical vehicles such as gold.

The desire for diversification is not limited investors. In ever increasing amounts, Central Bankers have also joined the party that arguably they were responsible for its demise 12 years ago. Whereas back in 1997, there was selling pressure on bullion brought about first by the governments of the Southern Hemisphere (Argentina, Australia), followed by Switzerland, Netherlands and the United Kingdom, now there is net buying taking place among Central Banks. Key among the buying group of late is China and India. We think this trend to broader purchases by Central Banks will continue leading to a new source of demand that hitherto was a source of supply as Central Bank selling intensified at the turn of the millennium.

In the absence of growing mine supply, we anticipate that bullion will continue to perform well over the next few years and possibly longer. Short-term gyrations however will also be the norm and in the past two weeks we have seen what we consider to be a normal (and arguably healthy) correction to the upward phase of a continued long-term bull market for gold.

The bank is accordingly raising its gold price forecast for 2010 and 2011 from $1,100 and $1,200 an ounce respectively, to $1,200 and $1,400.

And just in case you’re still concerned gold might be in something of a bubble:

We do not believe gold has experienced a bubble with the recent pullback of about 8% in prices, any more than the pullback in May-June of 2006 signaled the end of bull market for bullion. We continue to expect that investors will continue to add to positions or more likely start to build positions for gold exposure. It is our belief that at least in Canada, generalists are well underweighted gold equities relative to the 13% weighting of the precious metals sector on the TSX. For the rest of the world, the holdings are less than in Canada and therefore may also need to be adjusted upwards to compensate for higher risk levels for alternative investments.

And so, CIBC also presents the below three charts.

The first showing, the current bull run in gold (from the low in circa 1999, when the UK, err, sold off its reserves) against the 1970s/1980s bull run that started in 1972:

The second shows the current gold bull run against that widely-known bubble, the tech boom of the early 2000s. The trajectory is a bit, umm, different:

Not to worry though, CIBC says. The picture is still very different between gold equities:

Related links:
A golden sell-off – FT Alphaville
Gold retreats on talk of bubble – FT