|Summary: Gold has been hammered over recent times, but strong buying support for bullion and a return of broader investment support should push the price higher.|
|Key take-out: Additional exchange stability should free up Australian investors from worrying too much, over the longer term, about the exchange rate impact on gold.|
|Key beneficiaries: General investors. Category: Commodities.|
Following the rapid plunge in gold prices from October 2012 – almost $US600 or one-third of its value – we have in more recent times seen a bounceback of around $US200 ( 16%). But the gold price has dropped around $US40 over the last two sessions, to now sit at $US1,373.
So what to do? One key problem that investors have is that following a decade long, or more, bull-run, there isn’t a lot in the way of technical indicators to guide things. $US1,400 isn’t a particularly strong line of support of resistance or anything, and it’s a key downside that we lose information content from technical indicators.
Having said that, there is still very interesting information content to be garnered from the current action. Indeed, recent moves suggest to me that gold has a good chance of rallying further, and holding well into $US1,400, notwithstanding recent volatility.
1. The rally in gold has occurred despite a rally in the $US. Now, at the outset, the price action shows there really isn’t any consistent relationship between the two; however, theoretically, a stronger $US should act to weaken gold. Keeping that in mind – some might put the fact that they’ve increased together down to some sort of fear trade (ongoing problems in the Middle East). Except that we’re not seeing this fear trade replicated in other assets. The 10 year treasury yield, for instance, is up 140 basis points since May and there has been no correcting rally (fall in yields) as news broke that the US would attack Syria. This means the gold price move has its own momentum – it is driven by gold specific factors, not some fear trade or other secondary factors.
2. As Tim Treadgold noted on Wednesday (Minefield: Three golden prospects) real buyers, that is physical buyers of gold, used the recent price drop to lift demand. Indeed, it is the physical market that has largely been responsible for the sharp rise in gold of late. This is telling. Because while we were reading stories about the end of the gold bull run and how we should prepare for gold at $US800 etc, the real market looked at the price fall as a huge buying opportunity.
Chart 2 above shows world demand for gold by tonnage and by sector. To get a 2013 estimate I’ve taken the average of the first and second quarters of 2013 and annualised it. It shows what gold demand will end up being for the year on current trends. Note the big drop-off in demand from investors. This is about the only sector where demand for gold has fallen and the thing is, this fall in investment demand is really only confined to exchange-traded funds (the US mainly), which saw a 400 tonne fall in demand in the second quarter. If this continues it will be the first annual fall in demand from this sector and will bring investment demand to its weakest level since 2007. On the flipside, physical bar demand – for investment – rose by 75%!
Of particular note, and importance, there hasn’t been any real let-up in demand from central banks. That means the official sector continues to make a vote of confidence in gold. Demand is lower, down 60% over the year, but as you can see from the chart, it’s still high compared with demand over the last decade.
Anyway, my point is that real consumers of gold, as opposed to fickle ETF investors, wouldn’t be so keen to pick up extra gold at ‘bargain’ prices if they bought all the rhetoric about some structural change in gold demand – gold at $US800 or what have you. They’d let the price continue to fall and buy at a later date. They didn’t and consumer demand in China and India rose over 50%!
Now think about how an investor is going to react to that. The World Gold Council advises that the fall in ETF demand was largely a US phenomenon. For me, this indicates some herd panic mentality among those investors. Based on what, I don’t know. Some well-placed public relations from a hedge fund perhaps. Anyway, if they now see real demand picking up it should reassure them that the bearish rhetoric they were reading was just that – and not really anything of substance.
3. This bring me to my third point, which is that net long (or bought) positions in gold futures and options have increased sharply over the last few weeks – net longs have quadrupled since mid-July. This is a very bullish signal and means that in the derivatives markets, punters are taking bets that the gold price will increase. Certainly it may be the case that traders are not as bullish as they were earlier this year, but the momentum is in the right direction. Traders are not always right mind you, no-one is, and they were caught short in the gold panic earlier this year – but it is a signal.
The currency effect
Now so far this discussion has been about gold in $US terms. But of course you and I are subject to the vagaries of the Australian dollar, and no discussion on gold is complete without discussion on the currency.
On that score it appears, for now at least, that the Aussie dollar could be relatively stable for the foreseeable future. That’s largely because some of the thematics that have driven the dollar down don’t seem to be panning out according to the script.
So China isn’t having a hard landing, commodity prices, especially iron ore, aren’t collapsing and Australian growth overall is OK. Even the Reserve Bank looks like it might be on hold for a bit. However, and as I discuss in another piece today, it looks like the $US might push higher in the short term, which should offer some exchange rate support for the Aussie dollar value of gold.
Longer term, and on current trends then, we could be in store for a bit of exchange rate stability. An $A holding at US80 cents is going to be hard to achieve, but conversely, I don’t think the market is quite willing yet to buy into the strong Australian fundamental story, as is my view.
If I’m right on that, the additional exchange stability should free up Australian investors from worrying too much, over the longer term, about the exchange rate impact on gold – or in other words, whether the Aussie dollar prices will diverge from global trends because of currency moves.
All in all then I think there is a good chance gold will continue to find support – real physical support and, from the looks of things, broader investor support. If I’m right, this should see gold rise comfortably above USUS1,400 and hold there.