Ross Norman
CEO
Sharps Pixley, London
Since the peak in gold prices at $1922 in September 2011 gold has corrected sharply lower, bounced and then tracked sideways, occupying well worn technical trading ranges. The non-performance in prices for the last 18 months has left some investors disillusioned and they have expressed this by selling… there is every reason to think that their action has been premature.
For each of us who watch bullion prices, there are signs we look for that give us an indication of future price direction … for me it is how gold behaves under adversity – does it bounce quickly after a sell off – and how it behaves during quieter trading times – does it edge lower or higher; both give a good indication for underlying sentiment.
Stepping back from the shorter term price moves though, we see three reasons to be bullish and three bearish – on the bullish side is the strong if sporadic growth in Chinese demand (some domestic demand but almost certainly a significant part of the 800 tonnes of production plus imports going into PBOC (central bank) reserves). Secondly, the growth in central bank demand primarily from emerging nations is a trend or pattern set to continue; and lastly the strong growth in the small bar and coin demand. The bearish factors are also well identified, Indian demand is weak (with the Finance Ministry seemingly on a suicidal course to undermine the value of one of India’s largest assets), secondly a decline in ETF gold holdings by about 110 tonnes in the last 2 months and lastly the sharp fall in net long positions on COMEX. Encouragingly for gold bulls, the bullish factors outweigh the bearish in tonnage terms, but perhaps more importantly, the selling is primarily by those with a shorter term outlook, while the positive factors look likely to endure.
One might add to this issues surrounding gold’s supply/demand fundamentals – and these add a positive flavor to gold as well – this balance is again perhaps of more relevance to investors with a much longer term view and position in gold. Most importantly has been the collapse in new gold mine discoveries, declining from an average 10 per annum in the 90’s, to a single figure in the mid-00’s, with the last significant find of the last few years being in 2009 – and, given the sevenfold increase in gold prices, this has prompted an increase in exploration spend from $1bn pa to over $6bn pa today. Reflecting this decline in new finds has been the decline in mine head-grades, with the average gold content falling 23% over the last decade as many mines become exhausted. Gold is supply constrained with the situation likely to be become more acute.
More broadly, gold is witnessing a shift in supply/demand patterns which rather like the movement of tectonic plates are slow and glacial but occasionally manifest themselves in the form of a quake. Much of the selling is being met by fresh buying and hence the choppy price patterns we are witnessing. For many of those leaving the market there seems to be disappointment that price increases have lost momentum and the failure of gold to respond to ongoing economic shocks and further QE as they might have expected – for those entering the market the thinking is perhaps more about maintaining the value of savings in the longer run as gold is arguably the best preserver of wealth amongst all asset classes. In short, the sellers have a longer term view of the market and the sellers are the so-called “weak hands” with a shorter term outlook. For them, the worst never happened be that Greece leaving the Euro, a Euro collapse, US default, China hard landing – even perhaps the Mayan “Book of Days” too.
For a metal that has enjoyed 17% year-on-year price increases in dollar terms compounded for over a decade, more modest price increases may be on the cards but the story remains attractive. QE is likely to be with us for at least the rest of 2013 – this would suggest another $1 trillion of further balance sheet expansion by the US FED, black swan events are likely to remain less of a rarity than many of us had expected (with Cyprus reminding us only this week), debasement of currencies will be on ongoing theme for economies around the world (economic crisis or not…). Perhaps the best way to view gold is as an insurance premium where you get to keep the money that you pay in, if the worst you fear never happens – that argument holds just so long as the market is not in bubble territory and we are clearly not. In the meanwhile gold will track higher, but not always when and as one might predict.
Late last year Sharps Pixley forecasted that gold would average $1736 in 2013 – a rise of 5% over 2012. We hold to that view and believe that gold is currently about £130/oz below fair value. The migration out of gold by COMEX traders and the building of a short position has much to do with that… it also positions the market for a corrective short-covering bounce if the selling they initiated also loses momentum. Either way, with a greater polarization between longs and shorts, gold looks likely to be much more interesting in the months ahead, particularly when technical resistance at $1620 is breached.

Source : Bullion Bulletin