For now, gold remains captive to the flow of U.S. and global economic indicators and prospects . . . especially those that may influence Federal Reserve monetary policy.
With the U.S. economy far from a satisfactory and self-sustaining recovery, the news is likely to become increasingly positive for gold — with diminishing expectations of imminent “tapering” (that is scaling back the Fed’s monthly bond-buying program) eventually replaced with talk of additional monetary stimulus of one sort or another.
Home in the Range
At the moment, however, gold appears range-bound between $1370 and $1420 — bouncing around within this range on the release of every relevant economic indicator and every comment on prospective monetary policy from one or another Federal Reserve official.
Paradoxically, a significant break out of this trading range — either up or down — is likely to boost buying interest. On the upside, if the price moves much above $1420, the momentum and other program traders will begin migrating back to the bullish camp. On the downside, if prices move much beneath $1370 (and even more so near $1320 (if we ever see gold prices back to this bargain price level), physical demand from all corners of the globe will underpin the market and lead to a swift increase in buying.
Paper vs Physical
It is important to distinguish between the paper markets, which are reactive to the daily news flow and where most of the short-term speculative trading is occurring . . . and the physical market, which has been — and will continue to be — a giant sponge soaking up every ounce of gold available at prevailing prices and premiums.
Much of the “paper trading” is among a small number of dealers and institutional speculators — not only in the transparent futures markets, but also (and sometimes more so!) in the largely opaque and unregulated inter-dealer over-the-counter markets, also known as the “dark pools” of liquidity where high-volume trading goes on virtually unnoticed. For more, see my May 15th post “Dark Pools, Program Trading, and the Decline of Gold.”
And, I would include in this group of short-term paper traders the hedge funds that for several months now have been lightening their gold holdings (mostly in the form of gold ETFs) in order to participate in, and benefit from, the upward march in world equity markets.
I expect when markets turn — that is when Wall Street turns down and gold prices begin convincingly moving higher — we will see a reversal with some of these funds rushing back to gold, contributing to a surprising recovery in the metal’s price.
Gold is Forever
Importantly — and in contrast to the paper markets where trading is very short-term oriented — the physical markets have an increasingly long-term orientation. The Chinese (both on the Mainland and across Greater China) are accumulating gold, not to resell for a quick profit as prices recover, but with the intention of holding forever as an inheritance to be passed on to future generations.
Many retail buyers of bullion coins and small bars in Western markets are also long-term holders with little intention of taking profits anytime soon. These buyers are motivated more by fear than by greed — Fear of financial market breakdown, fear of monetary debasement and future inflation, fear of an uncertain economy, fear of government intervention in personal affairs, and so on.
Indian demand is less certain and typically more price sensitive — with sellers, often led by housewives selling a bangle or two, emerging on rupee-denominated gold-price rallies. The country’s central bank, the Reserve Bank of India, and the Finance Ministry raised import duties earlier this year and have taken other regulatory actions to discourage gold imports, which after oil are the country’s second biggest commodity import and a major contributor to India’s gaping current account deficit. These efforts are increasing the domestic price premium over the world price, assuring a rise in illegal imports, and ending the sale of old scrap gold to world markets. In any event, Indian gold buyers will gradually adjust to the higher domestic price and demand will return to past levels dependent on local economic conditions, especially in the farming sector, which is traditionally an important buyer of gold.
Don’t underestimate the bullish influence of official-sector demand on the future price of gold. Indeed, purchases by a number of central banks, especially the People’s Bank of China and the Bank of Russia (which are by far the two biggest buyers month after month, year after year) are unlikely to be sold within our lifetimes. These official purchases are intended not only as a vehicle for reserve diversification and reducing reliance on the dollar, the euro, and other old-world currencies — but are part of these two countries’ strategic goal of raising their respective currencies’ international reserve status and gradually reshaping global monetary affairs.
The bottom line is that when gold turns higher there will be insufficient liquidity and a shortage of available supplies — except at much higher prices . . . and many will be surprised by the magnitude and swiftness of gold’s next big leg up.