Mumbai to Buy? Sure. At a Price not High.

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Bullion prices worked their way somewhat higher (within a channel of from $790 to $805) overnight as a pause in the dollar's rally and hurricane fears-driven crude values gave buyers a bit more motivation than they had prior to the weekend. Indian demand was quite robust as the recent massive slide in value convinced locals that early festival-related buying may be wise. However, expectations remain that gold could fall under 10,000 rupees per 10 grams by the end of next month, in which case there could be a decent enough Diwali-related shopping season to make up for some of the damage in demand the country witnessed in the first half of the year. At the end of the day, while some buyers (investment funds) had pushed gold prices beyond the proverbial envelope, others (and perhaps the more important ones to this market in a historical sense) had held back and dug in until the prices tags started to show relief.

A volatile start to the trading week in New York was the order of the day as gold opened with a gain of $4.50 at $790.50 per ounce. Players were looking to housing starts data as well as inflation figures later in the week to provide direction to a market that has now seen five weeks of unwinding. Short dollar positions have been unwinding, long metals positions have seen the same. As of last Friday, all of the precious metals are now in negative performance territory for the current year-to-date. Gold has lost 4.5%, platinum 7.3%, silver 11% and palladium 19.6% respectively. Bloomberg -polled traders (generally batting at 60% accuracy levels) see more declines in store for the metal this week, with the $775 level once again being a possible target.

Silver rose 34 cents to $13.04 while platinum added $5 to $1362 and palladium was still in negative territory, losing $2 to $279.00 per ounce. One platinum ETF has lost 30 percent of its holdings by the close of business last Friday and has 46% less material under management than it did in early July. Geopolitics presented a mixed bag once again, with Mr. Musharraf bidding farewell to the Pakistani presidency rather than facing impeachment, and with Russia appearing to withdraw from Georgia soon, while one of its own lawmakers suggested that it may just mimic the US occupation of Iraq and stay for years. At last check, the dollar was trading at 77.06 on the index and at $1.47 against the euro, while oil was unchanged at $113.77 per barrel.

Since we are on the subject of Indian demand, let's take a look at how one local analysts sees matters in the wake of what has now been the longest slide in values since 2004. The Hindu Business Line's G. Chandrashekhar chimes in with an overview:

" Gold prices have seen a precipitous fall in the last few days and indeed in the last four weeks, taking most gold bulls by surprise. Speculators (euphemistically called investors) — on strength of whose support the yellow metal reached seemingly unsustainable heights — have deserted it in search of better prospects elsewhere. This is yet another evidence of how market prices may appear stretched for some time but cannot defy the fundamentals for too long. The gravity of the situation can be gauged from the price movement. In the cash market, the yellow metal traded on July 17 at $957 an ounce. By August 7, the market had already gradually declined to $873/oz; and on August 14, the spot rate was $807/oz.

Investors and investment funds, who had betted on a rise in gold prices, had to exit the market in a hurry to limit their losses. When the rally is sharp, it is not unusual to see an equally sharp decline too. Why did the sentiment change and why did investors liquidate their long positions? One of the key determinants of gold prices is the US dollar. Weakening US dollar, rising energy prices, inflation concerns, falling interest rates, and uncertainties in the broader financial markets drove investors to the well-known safe haven that gold is.

Inflation fears

As such, the direction of the gold price lay in the hands of investors. Investment funds had moved into gold over much of the past year seeking a hedge against dollar weakness and a store of value as increase in oil prices fuelled inflation fears.

Many of the concerns still remain; but the dollar has been rising against most currencies, particularly the euro, making gold in dollar terms less-attractive. Falling physical demand has also been a cause of concern. High and volatile prices have resulted in demand compression, especially in price sensitive markets led by India, which is the world’s largest importer and consumer of the precious metal. Imports have declined over the last three quarters; and jewellery demand is estimated to have declined by close to half. The physical balance of the gold market shows a modest surplus, rather than a deficit.

Forex market experts expect the dollar to continue to strengthen over the next 3-4 quarters. If this expectation were to materialise, gold will, barring exceptional developments, have to decline further or at best stay at the relatively modest levels as at present. On the Comex, the futures net long as a percentage of open interest is still high at 40 per cent (all time high 49 per cent), having fallen from 43 per cent following long liquidation. Yet, there is still considerable speculative froth left in the market. The froth can disappear sooner than many think if conditions develop favourably.

Short-term prospects

So, where would gold go from here? In the short term, it is a tough call to take. At around $800/oz, there is sure to be some resurgence of physical demand which could cushion the downtrend. Gold is perhaps closer to the floor now, and prices are likely to remain at the mercy of dollar movements and crude prices. According to experts, bouts of dollar weakness and constrained mine supply among other favourable external factors (mainly, geopolitics) are likely to support investor interest in the yellow metal. So, the current prices of around $800/oz and further dips may be a good buying opportunity.

Demand Erodes

In the longer term, however, if the widespread expectation of dollar strength materialises, it would be negative for the gold market. As for the Indian market, clearly, demand destruction has set in because of relentless rise in prices. Overall, agricultural incomes have risen but inflation is still untamed. The purchasing power of people is considerably eroded, especially in rural areas. No wonder, household consumption of physical gold has declined."

Volatility will dominate. Recovery rallies could come under selling pressure as previous supports have become resistance areas. Similarly, dips to lower levels may encounter sufficient bargain hunters to cushion them. The bigger picture is more important however, and it still reveals significant turning points in the making for the sectors we normally track.