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Gold at an Inflection Point?

The broad shape of gold's four major markets all stand at an inflection point right now...

, head of the European Central Bank (ECB), has described the world economy as reaching a "point of inflection", writes Julian Phillips of the

The dictionary tells us this is when a curve changes from concave to convex. So as not to confuse you, the economy is about to change direction – or has already begun – and is turning up.

This was not a minor statement, but it joins other central bank and Treasury indications that the worst is over and we can expect matters to improve. There will be the ongoing debate as to whether this is a false start or a real one but our concern is for its impact on gold.

Where does the Gold Price head now, if there is a recovery underway?

The first question to ask is what caused the rise in Gold Prices starting in 2000...? We had a terrific economic boom in the meantime, before the last two years of downturn. Even in the last two years of recession, gold attempted to mount the $1,000 level, pushed back by investor credit failure and the inevitable shrinking of jewelry demand and rising scrap market supply as jewelry owners sold gold to raise cash.

The rise of long-term investment demand countered those trends, and both scrap supplies and the downturn in jewelry demand appear to have peaked. But have they? It's not enough to just look at the charts investors use, but look at the market from several sides to see where it is telling us it wants to go.

Some analysts believe the Gold Price has seen the end of its 'bull' market and expect a fall to the $800 level. Some see it mounting $1,000 again before falling back. Others believe that we have seen a "reverse-Head-and-Shoulders" formation and that the Gold Price has only just begun its path upwards. For sure though, the price has reached a "Point of Inflection" too, we believe.

Many professionals rely entirely on the technical picture for guidance, using charts alone to judge the way forward. We hold, however, that today's market outlook springs from a monetary scene far closer to the Seventies than to the ensuing 25 years of monetary stability.  Hence, can one really compare the Technical picture of the last 25 years to the almost revolutionary monetary years that preceded it? We don't think so – and so we bring to our decision-making the fundamentals that we see now.

The economic, business and financial fundamentals are quite remarkably different from any seen by the present generation of money managers. They are world-changing fundamentals and we are at a "Point of Inflection" with those too.

The jewelry market meantime continues in its slump, and scrap is still pouring onto the market as never before. In the West, the price of very few pieces of jewelry is currently founded on their gold content. The metal has been judged a low-value input compared with workmanship. But this will now change, as history demonstrates over many thousands of years that gold is used in jewelry because it was and is expensive. The era of cheap gold is over, because as the harsh realities of the swings in the economy bring back the benefits of saving, once again gold jewelry will become an expression of wealth – even in the developed world.

Just as the drop in disposable consumer income forced a cutback on Buying Gold jewelry, an increase in that income will be directed to the more valuable gold jewelry as part of saved wealth, just as it is in India currently.

In India demand for jewelry has fallen because of the jump in the price of gold from below 10,000 Rupees for 10 grams of gold to over Rs.15,000. This produced scrap in large quantities, obviating the need for the Indian market to import gold between October '08 and April '09.

Will this last? We must remember that India once bought gold when it was $300 an ounce and got used to a $600 price later on. Once the $600 price was accepted, back came the Indian gold buyer to the market. This process has constantly been repeated since then, and that is the nature of the market – the world's hungriest. Once Indian gold buyers feel comfortable with a higher price making a new "floor", they return to the market. Likewise, when the new floor is recognized, scrap sellers of gold retreat. As supply then drops and demand returns, imported gold volumes jump quickly.

It is an almost emotional turn in the market. 2008 saw imports of 660 tonnes, with a peak the year before of 850 tonnes. Now cut out the first quarter of this year and see a return of the Indian investor, and we could see an average of 70 tonnes a month of imports for 2009.

The months from May through August typically see very little gold imported to India, so we can expect a potential demand of well over 600 tonnes in the last quarter if the price is still below $1,000.

In short, Western jewelry demand is linked not to the Gold Price but to levels of disposable income. Indian demand is linked to prices finding new 'floors'. We therefore conclude that the gold market has seen the worst levels in these two markets and that they too have reached a "Point of Inflection".

Investment demand, in contrast, works differently again. During the year before the credit crunch bit us so badly, demand for gold from a new source started to rise. During the crunch it rose to new highs overtaking many of the big central bank holding's levels. Primarily institutional, the arrival of this demand in the gold market brought a wave of buying that revolutionized it and changed its nature and seasonality. As we highlight in an earlier part of this newsletter (for subscribers to, this particular demand now rules today's market. Lately, it has seen only tiny additions to its holdings.

Will Gold Investment demand return to levels seen at the beginning of this year? It is critical to track this carefully. Because portfolio managers have to assess whether the recovery in the global economy will bring stability with it or not. This is apart from the recovery itself. The two do not go hand in hand!

The systemic fractures and ongoing weaknesses of the monetary system, and the global economy have implied that the powers-that-be are not as in control of the scene as they would have us believe. Worse still, it is incumbent on them to convince us that they are.  So if the global economy does lurch from deflation to inflation, the resulting loss of confidence in the system will see this new form of demand for gold surge to levels never seen before.

As institutional managers assess the way ahead, Gold Bullion is now a hot topic in their investment meetings.  As they have shown to date, they remain holders of the gold they have bought, but the question that we have to answered is "Will they buy more?"

The capacity still available to investment managers for gold in their portfolios is still huge, so there is enormous room for new buying of the shares of the Gold Exchange Traded Funds (ETFs). But whether it's right to say that investment demand has reached a "Point of Inflection" remains critical – because it would perhaps be the most important inflection for the Gold Price.

Over in the official sector, global central banks have turned buyers of gold – a similar point of inflection – after many years of net disinvestment. New disclosures show that China and Russia are buying around 10 tonnes a month of gold (Russia bought 6 tonnes last month and China is buying around 5.6 tonnes a month locally), and the signatories of the Central Bank Gold Agreement – i.e. the European banks – have lowered their sales to around 2- 5 tonnes a month.

Developed world central banks have been committed to selling gold, but only as part of the effort to establish the Dollar and later the Euro, as the only real money around. They were successful during the period from 1980 to 2000. Now, particularly in the last two years, the credibility of the paper money system has received such huge body blows that it has left the concept of fiat money suspect.

After all, all such currency is simply an IOU from the government that printed it. The value of these IOUs has eroded badly, first from the global banking/credit crisis, and second from global recessions and the unleashing of the printing presses. Last week saw the previous world empire, the UK, suffering the ignominy of a poor credit rating. Most observers including Jean-Claude Trichet (but not yet including the US Fed's Ben Bernanke) are clear that the next stage in the global economy will be an inflationary one.  As the mountains of money that have been printed in the last year, combined with a recovery in the global economy grow we expect the global monetary system to be swamped. Any traditional money tightening to fight this inflation will crush the new found confidence that consumers may have in the recovery.

The choice of letting inflation blossom or facing another bout of deflation will face each government and central bank.  How can this not breed volatility and instability? Central banks, as a matter of prudence and duty, particularly in the developed world, cannot afford to continue with their somewhat anti-gold pro-paper currency stance. Hence central banks – as a class of investor – are now buyers. Should they see an opportunity to buy gold in large quantities like the much-discussed IMF Gold Sales, they will jump at it! (The open market is too small and their presence would incite price rises.)

Signatories of the current Central Bank Gold Agreement have almost completed the sales of gold they had announced previously, and they appear unlikely to make new announcements to sell more gold. Developed world central banks are certainly reviewing their stance on gold and are likely to keep a firm grip on the gold they already have.  Like South Africa is doing, central banks buyers are dipping into local production.

Finally, industrial demand for gold rides on the state of the global economy. Its use in electronic and other applications is not as price sensitive as many feel. Once the economic recovery gets into its stride, industrial demand for gold will rise too. As a major gold market factor, industrial demand is in the shadows of other forces and regarded as a small contributing element to the gold price only. But it too is at a "Point of Inflection".

JULIAN PHILLIPS – one half of the highly respected team at – began his career in the financial markets back in 1970, when he left the British Army after serving as an Officer in the Light Infantry in Malaya, Mauritius, and Belfast.

First he worked in Timber Management and then joined the London Stock Exchange, qualifying as a member and specializing from the beginning in currencies, gold and the "Dollar Premium". On moving to South Africa, Julian was appointed a macro-economist for the Electricity Supply Commission – guiding currency decisions on the multi-billion foreign Loan Portfolio – before joining Chase Manhattan and the UK Merchant Bank, Hill Samuel, in Johannesburg.

There he specialized in gold, before moving to Capetown, where he established the Fund Management department of the Board of Executors. Julian returned to the "Gold World" over two years ago, contributing his exceptional experience and insights to Global Watch: The Gold Forecaster.

Legal Notice/Disclaimer: This document is not and should not be construed as an offer to sell or the solicitation of an offer to purchase or subscribe for any investment. Gold Forecaster/Julian D.W. Phillips have based this document on information obtained from sources they believe to be reliable but which it has not independently verified; they make no guarantee, representation or warranty and accepts no responsibility or liability as to its accuracy or completeness. Expressions of opinion are those of Gold Forecaster/Julian D.W. Phillips only and are subject to change without notice. They assume no warranty, liability or guarantee for the current relevance, correctness or completeness of any information provided within this report and will not be held liable for the consequence of reliance upon any opinion or statement contained herein or any omission. Furthermore, they assume no liability for any direct or indirect loss or damage or, in particular, for lost profit, which you may incur as a result of the use and existence of the information, provided within this report.

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