Gold rush: Is the yellow stuff really a ‘safe haven’ or ‘fools gold’ against a falling USD?

Gold as an alternative investment asset: Currently, equity markets, the DXY and EUR are trading off headline risks, promoting gold as an alternative investment asset. Gold prices are encouraged due to risk aversion from the US and Europe debt issues, while the prospect of QE3 as hinted by Fed chairman Bernanke has also fueled expectations of higher medium-term inflation and a weaker dollar. Coupled with the threats of a credit rating downgrade if the US’ debt ceiling is not raised on time, safe haven assets like gold may continue to extend its winning streak.

Drivers for gold remain the same: The first hint of QE3 on 14 July resulted in a surge in gold prices by more than $20 to $1,585.50/oz, suggesting that gold still stands as a tool used to hedge against the potential rising inflation and a weaker DXY. VIX is testing the key 20 handle amid ongoing uncertainties. Our call in May for gold prices to exceed $1,600/oz at year end has materialized earlier than expected.

So what now? Gold prices ultimately depend on the global economic outlook. Key events to watch out for would be the US decision on its debt ceiling on Aug 2 and ongoing developments on the Eurozone debt crisis. A quick resolution for either could stall the gold rally in the short-term, but the medium-term uptrend for gold prices remains structurally intact in our view. On the other hand, the QE3 trigger should prove supportive of inflation expectations, stymie the USD and in turn add to the attraction of gold.

Our base scenario is for the global economy to continue its softening till end of summer, and after which, global growth may regain some traction, which could boost some investor demand for risk assets again. Till then, gold is expected to be demanded as a safe haven tool to hedge against the falling dollar and potential inflation.

The breach of $1,600/oz is unlikely to mark the end of the gold rally as long as global sentiments remain pessimistic and investors remain risk averse. Real gold demand from China and India are also expected to remain robust for the year. Thus, we look for higher gold prices to average $1650/oz in 3Q11 and $1625 in 4Q11. However, should QE3 becomes a reality, then do expect gold prices to trend even higher to hit a possible high of $2,000/oz at year end.