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Despite the winding down of East Asia’s Lunar New
Year gold buying binge, I expect the yellow metal’s
price will continue to move up
in the weeks ahead - but not without some struggle as gold works
to reestablish upward momentum and renewed credibility.
Historically, with the arrival
of the Lunar New Year, gold demand and
the metal’s price typically enter a seasonally weak period — but the typical seasonality
is no longer
a reliable guide to gold price
prospects.
The usually
weak summer months this past
year saw gold run up
to new historic highs above $1,900 an ounce . . . and, contrary to expectations, the seasonally strong autumn months saw gold prices
fall sharply, all the way back down to $1,525 or thereabouts.
Changes on the
Demand Side
Now, with winter upon us, I don’t expect gold prices
will drop with the temperature as they often
have at this time of year. Instead, I believe that there have been
important changes on the demand side
of the gold market that
now overpower or outweigh any
remnants of seasonality.
For one thing, institutional
investor participation has grown by
leaps and bounds, as has
retail demand for bullion coins
and small bars.
Similarly, official-sector gold accumulation has become an extremely important non-seasonal factor effectively removing several hundred tons of gold from
the market in each of the
past two years.
I expect central bank demand not only to continue but possibly expand in 2012 with China and Russia leading the pack — and a growing number of countries underweighted in gold relative to U.S. dollar-denominated reserves joining in this official-sector gold rush.
These buyers
- private investors and governments alike - don’t care what the weather
is. Instead, their behavior is a reaction to macroeconomic and political developments in their own countries and around the world
without regard to the time of
year.
And, institutional traders and speculators - who lately account
for much of the short-term
volatility in the metal’s price - are often governed
by new and changing trading modalities and algorithms.
For example, the increased importance of “portfolio rebalancing” by index, commodity, and hedge funds
has, for now, introduced a new element of
seasonality, one that weighed heavily on gold in late December and early January
when many of these funds
were large-scale sellers of gold,
mostly in futures and other derivative markets, but nevertheless with negative price consequences that are now past.
Shrinking Free Float
Continuing Chinese gold accumulation has important long-term significance that is not generally
acknowledged by many gold analysts
and market pundits. Simply put, China’s private-sector gold purchases
are unlikely to be sold
back to the world market any time soon, certainly not for many years to
come and even at much
higher prices.
Not only are gold exports
from China illegal - but many,
if not most, Chinese savers and investors
buy gold with no intention
of selling sometime in the future just because prices rise, inflation subsides, equity prices tumble, or any
of the other drivers that might trigger
sales by Western investors. For the Chinese, these are long-term, quasi-permanent holdings.
The same can
be said of central-bank gold purchases, not just by the People’s
Bank of China, but by most of the
central banks that have been
building gold reserves in recent years.
As a result,
the supply of available gold in the marketplace
— what I call
“free float” – is diminishing . . . and any pickup
in gold demand for jewelry, investment coins and bars, official
reserve accumulation,
etc. will have a more
high-powered affect on the metal’s price than might
have been the case a few
years ago.
More Money Will
Fuel Gold’s Ascent
Prospects of further monetary
easing by the world’s three top central banks - the U.S. Federal
Reserve (the Fed), the European Central Bank (the
ECB), and the People’s Bank of China (the PBOC) - also know no season and
are also becoming more supportive.
In each region, signs of slowing economic
activity, unacceptable or worsening labor-market conditions, and continuing restrained consumer price inflation suggest that central banks will press harder on the monetary accelerator in the months ahead.
As in the past, quantitative easing or other steps
to raise credit availability by the Fed,
the ECB, and the PBOC could fuel surprisingly big moves in the price of
gold in the months ahead.
Wild Cards
Finally, there are a number
of “wild cards”
that may affect gold prices
- for better or worse - in the days and
weeks ahead. At the top of
my list:
- America’s political log-jam and Washington’s inability
to reach a consensus on important federal debt and budget measures;
- Heightened tensions in the Middle East - with saber-rattling by Iran, oil-price uncertainties, approaching Egyptian elections, and the threat of civil war in Syria;
- Europe’s continuing sovereign-debt crisis, further downgrades by the credit-rating agencies, the looming Greek default and departure from the euro-zone, possibly followed by other deeply indebted countries.
- And, perhaps
most importantly, how the U.S. dollar reacts in world currency markets to any of these
unfolding developments
and to further monetary easing by the U.S. Fed.
Jeffrey Nichols
NicholsonGold.com
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