The Gold Price in Focus

By: Julian D. W. Phillips | Fri, Nov 7, 2003
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Gold, the most extraordinary metal, where increased demand can reduce supply, where selling pressure tends to increase supply, where commodity demand can be replaced by investment demand, where the price can be driven higher by factors unrelated to its use as a metal. - Gorgeous gold, a focal point of monetary value and unprintable!

In the final part of this series of articles, we bring into focus all the factors that contribute to making the gold price, with their relative influences. Unlike any other commodity the gold price factors develop a synergy, interacting,? giving each other additional impetus magnifying the impact of each individual factor beyond its inherent weight.? Hence to understand the price we have to be able to fit each factor together into the whole picture and see how they interact with each factor. We have used the illustration of the sea to do this, as it is the nearest parallel we know that explains just how the gold price works. The market place, in our illustration is therefore the beach, where the lines of waves define the price. In broad sweeps the three major influences on these lines in the sand are: -

 •  Macro economic factors resemble the Currents'? of the sea. - It is these that create a climate of stability or instability against which, like a thermometer, the gold price works? The greater the structural instability in the global economy or its major parts reflect, the higher the gold price and consequential demand for gold rises. The less important 'tides', 'waves', or 'shore surf', are completely dominated by this 'current'.

 •  The 'Tides' are factors precipitated by the 'Currents' in the medium term, albeit they constitute major medium term influences in themselves.

 •  The individual 'Waves' are the very short to medium term precipitants of both 'Currents' and 'Tides'. These factors define the actual price of gold. These waves make all the sound and fury on the beach finally drawing the lines in the sand, namely the gold price itself. At times, very short term and capricious influences, like the weather [media reports - dealers influence on the price - speculative pressures - etc] give these waves their most expressive features.

"Current" factors

The fundamental or macro-economic factors have long term affects on the gold price and can set the scene and control the underlying direction of the price for up to a decade or longer. In the last fifty years the most telling factor in the history of gold in that period has been the international spread of the U.S. $ and the state of the economy backing it.

The recent history of the $ / Gold relationship can be broken into these main periods: -

 •  Breakdown of the post-war fixed value of the $ and other currencies in terms of gold. This lasted until the $ was devalued not once, but twice, against gold, finally floating against both it and other currencies in the early 1970's.

 •  The rise of the gold price reflecting the cheapening of the $ in terms of its over issuance and the inflationary environment that persisted for the next around fifteen years until gold hit $850 an ounce.

 •  The period that began in 1980's when the U.S., the I.M.F., followed by attacks on gold by individual nations, in support of the U.S., sold gold down in price against the $ until 1999.

 •  The period from 1999, when the world's leading Central Banks, announced that they would sell no more gold than the sales that had already been arranged, prior to September 1999, until now.

When the major gold price boom began to be experienced in the late 1960's and early 1970's, the major macro-economic factor was the decay of the $. Originally this decay began with the instabilities produced by excessive printing and exporting of the U.S.$, which were known as 'Eurodollars' [$ outside the States]. Growing into the global reserve currency, it replaced sterling, helped enormously by the pricing in $ of oil, by the entire world. With most economies importing oil, no other currency could compete effectively.

The U.S. kept a firm grip on these "external" $. In time the volume of $ held worldwide, rose to 76% of the world's savings and 85% of the world's trade. Gold highlighted the overprinting of the $ and rose in price to $850 an ounce in response. It had to be discredited so as to remove this condemnation of the $. The international, open market auctions of gold were designed to suppress the price of the metal.

So the $ prevailed, not just over gold but over all others currencies. As if to emphasise the point, the future of the U.S. economy, plus the fall of the $ against others currencies, is now critical to the well being of the entire global economy. Why, because as the extent of the $ hegemony grew, so its relative influence on the world's stability also grew. Indeed, as of now, the control that the U.S. government has on world finances is irresistible, making the $ the most effective instrument of imperialism ever seen.? The U.S. $ is so unstoppable an influence that its control is manifesting itself slowly, but surely, over all other financial instruments world-wide.? The $ is now the currency of the global financial empire of the United States.? It is now the fulcrum of global stability.

A Change in the "Current"? - A restoration of real growth expectations over the longer term in the U.S. will swing the macro economic current back to a falling gold price. A willingness on the part of the rest of the world to have the U.S. currency in total domination? would have to follow, before there was a restoration of confidence in the $. In turn, should this confidence be restored in this way, the threat from the Euro would diminish and the gold price resume its falling trend. But this seems to be a most unlikely future, at the moment!

"Tidal" factors

Central Banks - The first reaction to this 'current' will be the Central Banks of the world. Perspicaciously eying the future, their first reaction to the $'s future was the "Washington Agreement" in September 1999, which guided us all to the attitude of the Central Banks, then and in the future, towards gold. In this agreement they reinforced the "Reserve Asset" role of gold. Perhaps they foresaw the dangers creeping up on the $ and the future role of gold. The agreement was a timely precaution giving an early warning that the falling gold price trend was to halt and the gold price to rise, once the turnaround was complete. Central Banks have not and will not be capricious in their attitude to gold, selling one moment, retaining gold the next.? No, gold is and will be far too important to the sound functioning of the global monetary system, in potential crises, such as the one we described above. The Central Banks attitude to gold will be the most important "tidal" influence on the market there will be.

Second only to the macro-economic factors, Central Bankers form the central point of the "Tidal" factors.

They can? influence the market in three major ways. First, by selling gold, as they are currently doing. Second, by not selling gold. Thirdly, by buying gold. They are currently sellers of 400 tonnes a year, until September of next year. To gauge this influence we ask you the reader to imagine that they do not sell this tonnage. The result? The supply / demand picture would change as quickly a an extra weight being dropped onto an evenly balanced set of scales. The gold price would take off not simply by their absence, but by their obviously positive attitude to gold.

Next their buying of gold. If they were to use the tactics Britain, the I.M.F. and the U.S. have used in selling gold and went to the open market with a public announcement that they were going to buy gold, again the price would roar in its upward path. Today in line with the "Washington Agreement", individual Central Bank sales are not preceded by public statements, so as to not disturb the markets into pushing the price down.

But seeking to act prudently and in the interests of themselves and their citizens, Central Banks buy in the shadows, minimising the impact on the gold price, if possible. So we see Central Banks like those of Russia and China buying locally produced gold rather than go to the open market, where they would be like a cat among the pigeons. Their behaving like this and buying 'off-market', impacts only on the supply of gold to the market coming through, byway of a reduction of new supplies to the gold market[not selling gold].

Hence, the principal "Tidal" effect in the gold market is the activity of the Central Banks. ?

Producer de-Hedging - The second major tidal effect arose as a consequence of the actions of the Central Banks. Gold Producers built their hedge positions to maximise income in a falling market. When it became clear that the Central Banks were no longer going to sanction a falling gold price, these? 'hedge' positions were re-examined, in light of the "Washington Agreement" It became clear to them over time that they were vulnerable to a situation where the gold price they had achieved, through their 'hedges', could turn out to be lower than current gold prices. Such a prospect was unacceptable and defeated their commercial objectives as well as those of their shareholders.

The gold price then established a rising foundation, so gold Producers accelerated the exiting of their hedges as quickly as the market would bear, without pushing the gold price into orbit.

By exiting the hedge prematurely, with the "contango" [interest rate profits from selling forward] in their hands as part of their profits, as well as the contract price, in a still profitable deal, led, in most cases, to the Producers doing better than selling their gold at current gold prices. Only now are the prices achieved in the "hedges" either at current prices, or below them. The Central Bankers, with regard to the industries continued soundness, acted responsibly, in warning the market of their future actions in the gold market. It was a consequential reaction to these prospects for the gold price, that caused Gold Producers to the extraordinary act of becoming major buyers of gold. The process of de-hedging has produced hundreds of tonnes of demand for gold in the last two or so years.

We now see the de-hedging process continuing until hedge positions are down to manageable levels when measured against rising gold prices.

New gold supply - A less important "tidal" factor is the reducing supply of new gold to the market. Much argued about and a potential hangover from the days of the dropping gold price over such an extended period, exploration for new supplies has dropped off considerably to the point that a declining quantity of newly mined gold is forecast for the future, by many. Because it takes around five years from the discovery of a gold deposit to it supplying gold to the market, the volumes of gold available to the market have been constricted for 5 years more or less, irrespective of the market price of gold. A price averaging around $350 - $450 may well bring about a wave of exploration. South Africa could be the exception to this, as the government of S.A. eyes the profits of the mining companies, as well as their shareholding with rapacious eyes. If they continue this approach, they may well discourage future investment, irrespective of the price of gold, because of the uncertainty of potential profits.

Investment? Demand -

As the "current" factors, followed by the "Tidal" factor of the Central Bankers activities and intentions, establish themselves as near term realities, so the next consequential factor appears in the market place. Stemming from institutional and informed high wealth individuals, longer term? Investors, constantly seeking the highest net returns from their investments, appear in the market. ? They are the last major "Tidal" factor entrants to the market, not because they don't accept the instability waiting in the near and far future, but needing to get the exit and entrance points right in all investments, they act when they see the imminent prospect of falling prices on other investments before entering gold investments, just ahead of their price rises. Following both the 'current' factors and major 'tidal' factors, they are, in themselves, a 'tidal' influence. Once they make their appearance, they are persistent buyers over a period, holding their investments for the longer term. Their buying capacity is enormous, indeed a one percent shift of investments from the world's Stock Exchanges alone, would send gold prices towards four figures. When they are seen on the 'beach' make sure you are in the market.

Remember the maxim; if you see a Swiss Banker jump out of a window, follow him, there's money to be made on the way down!

A new trend in investment demand has now been established by the World Gold Council. A new type of Investor, the "small man", could well become a new 'tidal' influence. He buys shares like "Gold Bullion Limited" and the about to be listed "Equity Gold Trust" in New York, where each share represents one tenth of an ounce of gold. At last gold is within his reach in a user friendly manner. Demand from this source is likely to be even longer term and could rise to proportions that could throw the scales off-balance, fairly soon.

If China follows a similar path and allows individuals to own gold, as expected fairly shortly, the demand from the two investment sources is set to be a long term, incoming 'tide'.

"Wave" factors

As completely reactive elements of the gold price the waves are short term, rising and falling constantly irrespective of the currents and tides. But in response to the current and tidal factors, they, as 'waves' on the 'beach' called the market, are what we all see in the day to day gold price.? As observers, this is what we see. This is what is reported day by day in the media. Much is made of each rise and each fall. Indeed we through our Technical Analysis, as you have experienced in "Changing Tack" as well as "Gold-Authentic Money" have made excellent profits from these waves, far more than the straightforward tidal influence of trends. These 'wave' influences are made up of "Speculators", "Commercials" and "Dealers", who have the very short and short term gold price factors in sharp focus in front of them.

Speculators - Commercials - Dealers

Each of these individuals seeks to profit from his own activity, using the market to push and profit, from the price on any pressures he can bring to the market.

Commercials have other motives, doing all they can to avoid gold price risks, as their business is to add value to the gold, through their work.? Consequently, they buy when they believe they see a sustainable stable gold price and withdraw from the market when they believe the price is volatile or overpriced. Such actions can and do add volatility to the gold price.

Speculators and dealers profit from movements in the gold price not in a static price, so do all they can to make the gold price go their way. They make or respond to media reports, like the weather affects the waves of the sea.

The media, in turn, do all they can to highlight volatile factors. After all a report that simply reports "a change in the weather approaching", is not nearly as effective as a report saying "the gentle tranquillity of the day, was threatened by a storm bearing down on the defenceless village". While newspapers continue to report no good or neutral news, the gold market will find itself battered by any story, true or false that can gain our attention. The intention of the media is to whip up the 'surf' so as to keep our attention.

But at times, these weather influences can have a calming affect [in the absence of dramatic news] on the sea, allowing us to see the underlying currents and the tides clearly and without the distractions of wind and surf, such as when the gold price is in a 'consolidation' phase.

At times the winds may be howling, whipping up the wave and surf to give the dramatic appearance of more important features, then subsiding in a moment, back to a calmness, sweeping away the driving force they appeared to have, such as when speculative influences became convinced that the war in Iraq was a key factor in the gold price. The rise in the gold price was $70+ at that time, as was its subsequent fall, leaving the price right back where it started. In trying to dominate the gold price, which they did for the short term, all their efforts to run the price up were defeated by the inactivity of all other players, who stood on the sidelines, watching the speculators, 'full of sound and fury, signifying nothing' until they gave up their positions, before minding their place and waited for the major influences to return to the fore.

The gold price before and during the Iraqi war beautifully illustrated the point that, at no time do these 'weather influences' have the power to override either the 'tides' or 'currents' of the sea, which always return to dominate the gold price.

Having covered the shape of the gold price sea, we need to see just how they come together, to finally set the line in the sand, the gold price.

The synthesis of the Gold Price

As with our illustration of the sea, so gold market factors can work together or seemingly against each other like a wave running up the beach in an ebb tide.

 •  Currents dominate unchallenged, with all other factors touching a forelock to them in responding reaction.

 •  "Tidal" factors consequent on the 'currents', are the first distinctly visible influences acting so effectively that all other, lesser, factors follow their direction eventually.

 •  The 'waves' themselves often seem to be reacting in an opposite manner to these fundamentals, but always follow their lead acting in line with 'currents' and 'tides', whilst they move too and fro, making the market active and often volatile, at all times, sometimes moving up the beach in an ebb tide and sometimes down when the tide rises.

With the different objectives of the different participants at different times, the make-up of the price itself changes in a completely different manner to other commodity price structures. Each factor adds a layer onto the gold price, coming in at different times to each other, each having the potential to dominate at different times and with different weights.

 •  Of late the long term Speculators [waves] have held sway in massive quantities. Or were they Investors in disguise?

 •  Seasonal physical buyers [Commercials] are stronger this year than seen for some time, adding a strong inward flow to the sea. Their appearance being seasonal causes speculators to pre-empt their demand pushing the price up ahead of their presence. Commercials being hardened veterans are not fooled by this volatility, standing back until it settles and a price level convincingly, established. These two 'wave' effects, are constantly watch the 'tides'.

 •  The Major 'current' effect these days, is the decay of the $ and the threat from the Euro, promising instability in currency values, making the 'safe haven' of gold attractive, long term.

 •  Central Banks are warning the market of a new Central Bank Gold Agreement, on the same lines as the "Washington Agreement" in September 1999. Consistent with this is their determination not to 'disturb' the gold market, but to announce future sales post September 2004, as the German, the Dutch and the Swiss have been doing of late. Looking at their behaviour in the light of the "Washington Agreement" it is clear that there will be little departure from the underlying principles of that agreement. Despite this 'tidal' influence both the media and the 'waves' of the gold market do their utmost to incite volatility and uncertainty in the future of these agreements.

 •  The perspicacious Investors have recently made themselves visible. They are not driven by the 'waves' at all, except in their decisions on entrance and exit points. Their inherent power, once they decide, 'en masse' that the time is right, the Investor could impact on the gold price with a volume that would astound the market.? But the Central Bankers, in particular, are aware of this possibility and tread lightly, so as not to precipitate such a flood. The Investor can certainly drive the Jewellery trade out of the market and replace him, as the Speculators did in the last run up. ?

 •  The Central Banker, should he turn buyer from the open market, would do so as unobtrusively as possible, hoping to leave the market price to fundamental and market factors outside his influence. Should the Central Banks wish to openly go to the gold market as buyers, it would be to acquire large, very large amounts. The precedent set by history is for nations to confiscate gold owned by individuals within their borders and to bid the price up to up to 75% higher than market price, so as to shake out those holding gold as an investment, waiting for higher prices and not for security of value. These were the actions of the United States from 1933 to 1935 and set a precedent for stormy days.

The Gold Price Focussed

The sea flows in tides up and down the beach. The swells of the sea give a powerful shape to this momentum, but it is the shore itself where the waves can either reach a crescendo in spectacular "surf", or the tranquil lapping of the shore, as at dawn. So are the 'currents', 'tides' and 'waves' of the gold market as they synthesise to bring us the gold price. From morning until night the gold price moves, in the hands of the 'waves' sometimes erratically, sometimes within small bands and spreads. It can then jump 'the limit' up or down as price forces come together with the underlying forces to force the price into the right place.

The majority of this volatility comes from Speculators, who could, if allowed to, distort any stable market. This is why huge volumes of gold are traded, where possible, away from the market. The main players do exert a steadying influence on them and frequently kick the gold price a few $, back into line. The 'currents and 'Tides' prefer to avoid these capricious distortions by buying in a far more civilised manner at the "Fix" in the morning and afternoon, in London, where the main Bullion Banks come together representing both themselves and their large clients, [who make up by far the greater bulk of daily demand] and weigh the demand and supply of gold at that particular session, and agree a price where all deals are transacted, at the price agreed upon at this "Fix". In London, the price outside those sessions only reflect 'peripheral' transactions and arbitrage situations in other world markets, that don't want to wait for the "Fix".

The prices outside the "Fix" are at the mercy of the 'waves', the dealers themselves, as well as the speculators and smaller players, reacting to conditions and situations they find themselves in and made dramatic in the press.

After London hours, New York, the home of the large Speculator, takes the reins and makes the price. These two main markets essentially decide daily prices and will keep doing so until China makes its presence felt, as is expected, in the next year or so. Tocom in Japan fills the gap in Asian hours, but responds primarily to the other markets as a junior 'member'.

With the gold market, superficially linked, to "breaking news" the market is an interesting and exciting place. Recent special situations have seen contrived situations, where market players took delivery of gold from short positions, forcing the "shorts' to buy gold to cover their positions, resulting in gold prices moving $8 in one minute. So moment to moment assessments of the value of gold through the 'open' market price, should always be balanced by the "fixes" to get a reasonable price for gold, during Europe's day. Comex and Tocom, do not have such a system, ensuring all players 'join the scrum' in the market place. ?

With the low profile nature of the underlying forces, no market is so dependant on the major fundamental influences as is the gold market. These influences will override, surreptitiously usually, but forcefully always, until the gold price reflects the will of 'currents' and 'tides'.

With these diverse structural levels in the gold market, there is a persistent recipe for both an illiquid and a volatile 'open' market and gold price.

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Julian  D. W. Phillips

Author: Julian D. W. Phillips

Julian D. W. Phillips
Gold Forecaster

Julian D. W. Phillips

"Global Watch: The Gold Forecaster" covers the global gold market. It specializes in Central Bank Sales and details, the Indian Bullion market [supported by a leading Indian Bullion professional], the South African markets [+ Gold shares shares] plus the currencies of gold producers [ Euro, U.S. $, Yen, C$, A$, and the South African Rand]. Its aim is to synthesise all the influential gold price factors across the globe, so as to truly understand the global reasons behind the gold price.

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