Gold seen marching into 2006 with fanfare

By Atul Prakash

LONDON (Reuters) - The market fundamentals and macroeconomic factors that lifted gold's price more than 25 percent this year will drive it still higher in 2006, analysts say.

Leading research houses and investment banks have raised their price forecasts saying market basics, economic growth and inflation and gold's classic safe-haven role could attract more players into the market.

J.P. Morgan Securities have lifted its long-term gold price forecast to $500 an ounce from $450, with an average price of $558 in 2006 and $609 in 2007, while Merrill Lynch upgraded its 2006 estimate by 19 percent to $525 an ounce.

Most of the forecasts suggest average prices in the next year above $500, nearly double the level about five years ago.

"I don't see any reason why this interest in gold will go away," said Stephen Briggs, economist at SG Corporate and Investment Banking, which forecast average prices at $515 in 2006 and $550 an ounce in 2007.

"And this is against reasonably robust fundamental picture of sluggish supply, strong physical demand and the insistence of the market that the story on central banks is a positive one."

Last week, spot gold surged to $540.90 an ounce -- the highest level in nearly a quarter of a century, but slipped by more than 7 percent since then mainly on profit booking.

The market was abuzz this month with talk that some central banks planned to add gold to their reserves.

"There is no guarantee that there will be buyers, but the point is that the market thinks and hopes that they will and that's just the sort of bullish spin, even if it is against the actual fact," Briggs said.

Others also echoed the sentiment.

"If India, China and Japan are going to increase their reserves to a meaningful level for forex diversification, they will need at least around 4 to 5 years of mine production. The gold market is so small to allow for that," said Yingxi Yu, precious metals analyst at Barclays Capital.

MACROECONOMIC FACTORS

Dealers and analysts say that worries about inflation on the back of higher crude oil prices and concerns about U.S. economic growth, along with an unstable dollar, have boosted gold prices and the same factors would play a crucial role in 2006.

"People are still having worries about the economy and inflation. They still feel they want to have gold," said Simon Weeks, director of precious metals at ScotiaMocatta.

Analysts said the dollar was likely to weaken in 2006 and that should provide further boost to the metal.

"If the U.S. dollar happens to weaken then that would be good for gold probably, (although) gold has been dancing to its own tune recently so it doesn't necessarily follow," said Paul Merrick, analyst at RBC Capital Markets, who saw average gold price for 2006 between $540 and $550.

Gold generally rises with a drop in the dollar as the metal becomes cheaper for other currency holders. But the traditional inverse relationship has been broken in the past several weeks.

"We are now in a situation really where investor interest is so much that gold can benefit if the dollar declines, but it doesn't suffer particularly if the dollar strengthens," Briggs said.

Analysts said it was the positive sentiment generated by bullish comments by industry experts at different forums that had been helping the metal, and positive fundamental factors also helped.

"There is a lot of post-rationalisation by people who already hold long positions in gold and are hoping to drive prices higher, but this will continue to boost investor interest in gold," said Yingxi of Barclays.

Consumers are becoming more and more accustomed to higher gold prices and as a result, it's difficult to be aggressively bearish on gold, said Alan Williamson, head of commodity research at HSBC Bank.

INFLATION A WORRY?

Analysts said inflation was not an issue for most of the financial markets and was likely to remain subdued in 2006, but the gold market believed that it was a concern.

"So it doesn't matter really whether it is or it isn't, the gold market has decided it is an issue," Briggs said.

Gold had positive fundamentals, with global gold output to remain static for the next year before starting a slow decline because of lower ore grades at key mines.

"We remain bullish on gold over the medium to long term and believe that the arguments for gold outweigh the arguments against," Merrill Lynch said in its latest global commodity price review.

"Our thesis through the year has been that gold is in a longer-term uptrend based on a capping of supply from the mines in a combination with the prospect of an escalation in the evolution of the Chinese luxury goods cycle and jewellery purchases," J.P. Morgan said.