|Summary: The gold price has fallen by around 12% since October, but demand for the metal remains strong – particularly from central banks as they increase their gold holdings to offset their declining currencies.|
|Key take-out: The lower gold price most likely reflects a modest repositioning to deal with the rising uncertainty over central bank Quantitative Easing programs.|
Key beneficiaries: General investors. Category: Growth.
Since I wrote my October 15 piece Why gold won’t fold anytime soon, gold has, unfortunately, fallen by about $US80, or a bit over 12%. Tim Treadgold, in contrast, was bearish on gold in his December 10 piece Gold warning bells chime and deserves some kudos for what, at the moment, is looking like a good call.
Having said that, I’m not quite sure it’s time to be eating humble pie – at least just yet. Markets go up and down, and the reality is a 12% correction isn’t that unusual. Uncomfortable for an investor sure, and many may have already stopped out. But, it’s not unusual, and this is the fourth time over the last couple of years we’ve seen falls of this magnitude. In fact, this one so far isn’t quite as large as the others, although it’s fair to say it may not be over yet.
Take a look at chart 1 though. Note that in each case where gold fell hard, it then went on to correct back to the $US1800 level. So, if anything, it looks like gold has been range trading for the last couple of years between the $US1540 and $US1800 marks (roughly).
Now that is, in of itself, no reason to expect the range to be respected. It’s not implausible that this support may be breached and the great gold bubble will burst. But the bigger question, and the correct one to ask in my opinion, is why would it change? Have any of the factors that drove gold to $US1800 in the slightest way eased, changed or ceased? It’s an important question as gold approaches what is visibly a key support level. The truth is, I’m not seeing a lot in the way of pressure for that support level to be breached.
Take a look at chart 3. It shows the net long positions that traders or speculators have in gold (the blue area) against movements in the actual gold price (the red line). There’s a pretty good correlation, and while long positions have declined on an almost contemporaneous basis with the gold price, you’ll note that traders haven’t actually gone short and in fact are still very long – and there are very good reasons for that.
Firstly, the demand for gold is still strong. There was a small dip in demand from 4,582 tonnes of gold in 2011 to 4,405 tonnes last year, and that is helping to fan this whole debate about gold – that the love affair is over! But in what has been a 12-year bull run so far, this isn’t the first dip in actual gold demand. Demand also fell in 2003, 2006 and 2009. Demand went on to rebound and, as we know, nothing got in the way of the gold price surge. So I’m not really worried about a small dip in demand.
That’s especially the case when, as you can see from chart 4, this modest decline in demand is largely due to a fall in investor demand for physical gold (although ETF demand rose). Investor sentiment is fickle and can snap back. Note though that this fall matches the fall in long positions on gold that we saw in chart 3. Now demand in jewellery and also technology fell modestly, but magnitudes were negligible. In contrast, demand from central banks increased further last year. This is a very important signal for the market and should not be dismissed.
The reason official demand for gold is rising so sharply is that gold is a fantastic store of wealth. This is especially the case where cash is becoming useless as a store of value, as the world’s major central banks print to debase their currencies. Recall that this is one argument against the gold bubble view – gold’s value stems from the fact that cash is becoming increasingly worthless. That is, it’s intrinsic value has increased, which is why gold isn’t a bubble.
So then, to believe the bearish case against gold, you have to believe that investors have all of a sudden changed their mind on gold – on a sustained basis. That’s a brittle argument given how quickly sentiment can change. In any case, I think the fact that traders are still very long gold in conjunction with the fact that central bank demand has actually increased suggests there has been no such thing.
Instead, what I think we’re witnessing is a modest repositioning to deal with the rising uncertainty over Quantitative Easing – a bit of profit taking if you will after gold hit key resistance. For me, the move in gold comes down to the direction QE will take. I dealt with this issue in my February 11 piece QE plug won’t get pulled, so I won’t cover that again here. Suffice to say that I don’t think we’re going to see an end to QE. In fact, the Bank of England recently signalled to the market it is about to embark on a new round.
A new governor is being appointed to the Bank of Japan with an explicit growth and higher inflation target – and the authorisation to print until they get there. More broadly, I outlined in my October 15 piece that, even if central banks wanted to withdraw all this liquidity, they won’t be able to. So, why would anyone change their mind on gold when nothing fundamentally has or can change?
The advantage for investors at this point is that we are at a key support level. Watch closely what happens from here, as it could be a good point to pick up some more gold. Certainly, I would use any break through this level as a buy signal. Conversely, it’s not going to cost you a lot to put in a stop at another 7% or so from here – or anything, depending on how long you’ve been a holder.