Commodities | Feb 21 2013
On gold, “We have no positions as it still looks weak” was where we left the market last week and as we bounce around psychological support at US1600 we are questioning whether or not our bullish call goes on hold, or is this just the dip we have been waiting for to load up? At the beginning of the year we had all strapped on our bullish boots and loaded up with the metal expecting solid gains. Apart from traditional themes pulling us to the metal, the pre New Year prospects for global economic recovery and continued stimulus measures kindled our inflationary expectations, which craved further investment into the metal. The market was indeed long. So far these forecasts have not come to fruition as the metal has underperformed other asset classes, being down 6% for the year and it has suffered its biggest quarterly loss in more than four years.
1. Central Banks(CB) diversifying holdings. This theme remains firmly intact in particular for the Central Banks in Russia and China. Both have been switching USD for gold and as noted in last week's commentary they have a lot further to go. The idea for the Banks is to diversify their risk away for the USD and then into other asset classes. Central Banks have learnt that having gold helps alleviate an element within sovereign risk. The US with its holding of 8134 tons is the worlds largest and has successfully used its holding of gold for financial stability. Central Banks have been turning to gold; Russia and China are firmly convinced of its usefulness. Both have indicated their intentions and have a long way to go in purchasing programs so we can expect dips to remain well supported. As a guide 9.5% of Russia reserves are in gold (958 tons) in the US it is close to 70%. As such we can expect CB demand to remain with us for some time to come.
So what has changed here?
Essentially nothing has changed in respect of the CB activity in fact it is perhaps more heightened at the present time. However, CB ‘s do take time to purchase and they have time on their side. Accumulation we suspect will be ongoing and slow, primarily so as not to disturb normal market machinations, however we feel support from the activity will be there.
2. Geopolitical issues such as European sovereign debt crisis, US election and debt crisis, Iran/Israeli territory tensions, and expectations of a bubble bursting in the property market in China have all seen at varying times the demand for gold spike. It is interesting that China has just about overtaken India as the largest physical buyer of the metal. This we attribute to mainly domestic property issues which have driven people towards the metal as a hedge. The government has also encouraged the purchase of gold by citizens as a hedge against the property market. Overall, in times of potential crisis people see Gold as a safe haven trade. It has been a theme for the last 12 months as geopolitical events have placed a significant amount of risk on the table and as such investors have hedged their bets by buying gold.
So what has changed here?
Essentially, we are seeing the risk premiums associated with the current geopolitical events erode. Europe seems to still have issues however it is more fluid, the US elections and debt crisis is over or deals are on the table, China looks to be having a soft landing. The only real concerns lie with the Middle East but let's face it, it has been like this for a long time and will probably continue. Geopolitical risks are declining and so too is the need for gold as a hedge to these events. It is interesting to compare the Volatility Index against the Gold Price. As can be easily evidenced when volatility comes off so does the price of gold, as the reasons to hold the metal at the moment do not seem as significant. If you are buying Gold based on geopolitical risks then follow the VIX as an uptick here will provide a clue that the bull trend is back with us. We think that geopolitical themes are still with us however at the present time we feel they are just smoldering.
3. Current economic indicators for the global economy are pointing to the fact that we are amidst a recovery, albeit it is excruciatingly slow. The stimulus programs that have been implemented by Central Banks are helping economies pick up. This has been clearly evidenced by the uptick in the US housing sector and improved consumer sentiment numbers. Proper reasoning suggests that the significant amount of cheap money will have consequences for price pressures and if not closely monitored the prospects of inflation remain a real threat. As such we have seen bouts of hoarding whenever we get an uptick in inflation. The potential for inflation due to these programs has been a mainstay for many of the reasons to buy the metal.
So what has changed here?
Although we see signs of increased price pressure in various sectors, it is not following through to the overall inflation data. The prospects for growth remain tempered. The IMF in its latest release suggested that for 2013 that “the factors underlying soft global activity are expected to subside”, however any “upturn is expected to be gradual”. As a result concerns over inflation have to remain subdued. The current inflation outlook for the US for instance remains flat and if we do have a concern it is on a deflationary point rather inflation. So the reasons to buy gold on an inflation footing this quarter need to be reviewed. Also, another factor is that money will seek out high returns and as a recovery picks up those holding gold will seek greater returns in other sectors, as gold has no yield. Any economic recovery suggests there is greater return from moving to other assets such as equities and out of gold.
So when we consider the fundamental picture for gold we can see that the reasons to buy the metal have slightly shifted from last year: geopolitical events do not warrant a major premium at the moment; prospects for inflation remain controlled; and economic recovery is telling us to move into other asset classes. This could all turn around within a heart beat however. The CB theme which appears to be the only current bright spot, remains alive, and we are sure that CBs would see any major dip as an opportunity to buy more of the metal. Although as an influence on the market we feel the CB activity will have limited impact as it is mostly masked.
The current major concern is that holding to the bullish call involves ETF and CEF holdings of gold. Last year, due to uncertainty, gold purchases exclusively through ETFs was up 51%. The total holding of Gold in ETFs and CEF is upwards of 2105 tons. By comparison, China has 1054 tons and Russia 958 tons so if sentiment swung to the negative by about 10% then a significant amount of gold would need to be sold on to the open markets. Just a 10% swing in sentiment on current holdings would see 6.74 million ounces onto the open market. If negative sentiment continues then we will see a steady stream of sellers. This is an issue we have flagged before and could become an issue for gold bulls in the future. What’s the technical side of the equation telling us?
Technically, we have liked the picture for gold and actually still do. We have had a series of breaches followed by periods of consolidation since the high of US1922 Sept 11. This is a healthy market as it indicates to us that we should be in for more gains or at least a test toward US1830, to either conclude that a high is in place or that the trend higher will resume. Momentum indicators on a daily basis are looking to turn positive and on weekly basis they have already turned. So from a technical picture we are just looking for signs that a bottom is in place before we buy it. The market can still trade lower however if we see a break above US1635. Then game on!
Conclusion:
So in a nutshell, what are we thinking? We have been hardened bulls for some time for the metal but a few weeks ago we questioned the ability of the rally to be sustained given changes in the fundamental picture. Technically, it followed suit when the market broke through support at US1640. Our call for gold has been a neutral to bearish since, however we have been looking for the right time to buy back into the metal. We continue to look for the right time, however it is just not yet. We feel that the bull market is not over and that we are just in a holding pattern at the moment. We suspect that we could still be in for a deep consolidation period that may see it back to US1535 however, will continue to look for signs that the geopolitical and economic pictures will put a low in place. We feel the story will evolve to the bullish side in Q2 and Q3, however for the time being it just may be a question of toughing it out and perhaps putting a “little ice” in the belly on any positions. We are still bulls.
[Editor's note: Spot gold has fallen some US$33 to just above US$1570/oz since this article was written.]
.jpg)
This report is not, and should not be construed as, an offer to buy or sell, or as a solicitation of an offer to buy or sell, products, securities or investments. This report does not, and should not be construed as acting to, sponsor, advocate, endorse or promote products or any other products, securities or investments. This report does not purport to make any recommendations or provide any investment or other advice with respect to the purchase, sale or other disposition of products, securities or investments, including, without limitation, any advice to the effect that any related transaction is appropriate for any investment objective or financial situation of a prospective investor. A decision to invest in securities or investments should not be made in reliance on any of the statements in this report. Before making any investment decision, prospective investors should seek advice from their financial advisers, take into account their individual financial needs and circumstances and carefully consider the risks associated with such investment decision.
Find out why FNArena subscribers like the service so much: "Your Feedback (Thank You)" – Warning this story contains unashamedly positive feedback on the service provided.