Gold at the Point of Inflection?
Monsieur Claude Trichet, the head of the European Central Bank has described the world economy as, at a "Point of Inflection". The dictionary tells us this is when a curve changes from Concave to Convex. So as not to confuse you, the economy is about to or actually changing direction and is turning up.
This was not a minor statement at all. It now joins other central and Treasury official indications that the worst is over and we can expect matters to improve. There will be the ongoing debate as to whether this is a false start or a real one but our concern is for its impact on gold. Where does the gold price head now, if there is a recovery underway?
The first question we ask is, the rise in the gold price from 2000 until now was due to what? We had a terrific boom in the meantime, before the last two years of downturn. Even in the last two years of recession gold attempted to mount the $1,000 level, but was pushed back by investor credit failure and consequential shrinking of the jewelry market and rise of the scrap market in gold. The rise of long-term investment demand countered that. Both now 'appear' to have peaked, or have they?
It's not enough to just look at the charts investors have to take a look at the market from several sides to see where it is telling us it wants to go. From the outset of this examination, we have to point out that the factors involved are not slow moving and can change quickly making the markets ahead [gold included] volatile and permanently so.
The Technical Picture.
Take a close look at the Technical picture as drawn by Peter in the charts in the later part of this newsletter. The last two weeks have seen them move to a significant point that now needs to be confirmed clearly so as to point the way forward. Peter's charts, as always, give our view on the gold price, the supports and resistances that it may meet in the days ahead! [Subscribers only]
Some Analysts believe the gold price has seen the end of the 'bull' market and expect a fall to the $800 level. Some see it mounting $1,000 again before falling back. Others believe that we have seen a "reverse-Head-and-Shoulders" formation and that the gold price has only just begun its path upwards. For sure though, the gold price has reached a "Point of Inflection" too. Many rely entirely on the Technical picture for guidance on the way forward. We counter that, today's market springs from a monetary scene far closer to the seventies than to the last 25 years of monetary stability. Hence, can one really compare the Technical picture of the last 25 years to the almost revolutionary monetary years that preceded it? We don't think so and we bring to our decision making the fundamentals that we see now.
These are quite remarkably different from any seen by the present generation of money managers. They are world-changing fundamentals and we are at a "Point of Inflection" with those too. They are in fact, of a far more evolutionary nature than we have ever seen before.
Here again, not only is the global economy at a "Point of Inflection" but so is the gold market, but with a difference.
Jewelry & Scrap gold
The jewelry market is in a slump and scrap is pouring into the market as never before. In the West the price of very few pieces of jewelry is founded on gold content. This will now change for history has demonstrated over millenniums that gold is used in jewelry because it was and is, expensive. The era of cheap gold is over. As the harsh realities of the swings in the economy bring back the benefits of saving and increasing wealth, once again gold jewelry will become an expression of that wealth even in the developed world. Just as the drop in consumer's disposable income forced a cutback on buying of gold gold-involved jewelry, an increase in that income will be directed to the more valuable gold jewelry as part of saved wealth, just as it is in India currently.
In India demand for Jewelry has fallen because of the jump in the price of gold from below Rs.10,000 for 10grams of gold to over Rs.15,000. This produced scrap in large quantities obviating the need for the Indian market to import gold since last October, until last month. Will this last?
We must remember that India once bought gold when it was $300 an ounce and got used to a $600 price later on. Once the $600 price was accepted, back came the Indian gold buyer to the market. This process has constantly been repeated since then. This is the nature of that market. Once Indian gold buyers feel comfortable with a higher price making a new higher 'floor', they return to the market. Likewise, when the new 'floor' is recognized, scrap sellers of gold retreat. As supply then drops and demand returns, imported gold volumes jump quickly. It is an almost emotional turn in the market. 2008 saw imports of 660 tonnes, with a peak the year before of 850 tonnes. Now cut out the first quarter of this year and see a return of the Indian investor and we could see an average of 70 tonnes a month of imports for 2009. The months from May through August see very little imports to date, so can expect a potential demand of well over 600 tonnes in the last quarter if the price is still below $1,000.
So Western jewelry demand is linked, not to a gold price, but to levels of disposable income. Indian demand is linked to prices finding new 'floors'.
We therefore conclude that the gold market has seen the worst levels in these two markets and that they too have reached a "Point of Inflection" [lovely phrase that?].
During the year before the credit crunch bit us so badly, demand for gold from a new source, started to rise. During the crunch it rose to new highs overtaking many of the big central bank holding's levels. Primarily institutional, its arrival in the gold market brought a wave of demand that revolutionized it and changed its nature and seasonality. As we highlight in an earlier part of this newsletter, this particular demand rules today's market. Lately, it has seen only tiny additions to its holdings. Will it return to levels seen at the beginning of the year? It is critical to track this carefully every week, which we do in the Gold Forecaster.
Portfolio Managers have to assess whether the recovery in the global economy will bring stability with it or not. This is apart from the recovery itself. The two do not go hand in hand! The systemic fractures and ongoing weaknesses of the monetary system, and the global economy have implied that the 'powers-that-be" are not as in control of the scene as they would have us believe. Worse still, it is incumbent on them to convince us that they are. So if the global economy does lurch from deflation to inflation, the resulting loss of confidence in the system will see this new form of demand for gold surge to levels never seen before. As institutional Managers assess the way ahead, gold is now a hot topic in their investment meetings. As they have shown to date, they remain holders of the gold they have bought, but the question that we have to have answered is, "Will they buy more?" The capacity still available to investment managers for gold in their portfolios is still huge, so there is enormous room for new buying of the shares of the gold Exchange Traded Funds still.
So, it is true to say that investment demand has reached a "Point of Inflection", perhaps the most important one for the gold price?
Central Banks and Gold
With the disclosure that China and Russia are buying around 10 tonnes a month of gold [Russia bought 6 tonnes last month and China is buying around 5.6 tonnes a month locally] and the signatories of the Central Bank Gold Agreement have lowered their sales [based on the last two weeks figures - not far off the weekly average for the last few months] to around 2 - 5 tonnes a month, global central banks have turned, buyers of gold. In the Table above that we use to track these sales [in our newsletter] this is aptly demonstrated.
Developed world central banks have been committed to selling gold, but only as part of the effort to establish the $ and later the €, as the only real money around. They were successful during the period from 1980 to 2000. Now, particularly in the last two years, the credibility of the paper money system has received huge body blows that it has left paper money suspect. After all, all such currency is simply an IOU from the government that printed it. The value of these IOUs has eroded badly, first from the global banking/credit crisis and second, from global recessions and the unleashing of the printing presses. Last week saw the last world power, the U.K. suffering the ignominy of a poor credit rating?
Most observers including Claude Trichet himself [but excluding Mr. Ben Bernanke] are clear that the next stage in the global economy will be an inflationary one. As the mountains of money that have been printed in the last year, combined with a recovery in the global economy grow we expect the global monetary system to be swamped. Any traditional money tightening to fight this inflation will crush the new found confidence that consumers may have in the recovery. The choice of letting inflation blossom or facing another bout of deflation will face each government and central bank. How can this not breed volatility and instability.
Central Banks, as a matter of prudence and duty, particularly in the developed world, cannot afford to continue with their somewhat anti-gold pro-paper currency stance. Central Banks are now buyers. Should they see an opportunity to buy gold in large quantities [the open market is too small and their presence would incite price rises], like the potential I.M.F. gold sale, they will jump at it!
Signatories of the current central bank gold agreement have almost completed the sales of gold they had announced previously and appear unlikely to make new announcements to sell more gold.
Developed world central banks are certainly reviewing their stance on gold and are likely to keep a firm grip on the gold they already have. Like South Africa is doing, central banks buyers dipping into local production.
Central bank gold views have seemingly also reached a "Point of Inflection".
Industrial demand for gold rides on the state of the global economy. Its use in electronic and other applications is not as price sensitive as many feel. Once the economic recovery is striding, industrial demand for gold will rise too. As a major gold market factor, industrial demand is in the shadows of other forces and regarded as a small contributing element to the gold price only. But it too is at a "Point of Inflection".
Point of Inflection, Up or Down?
Is the future for gold Concave or Convex, up or down? Certainly a gold price around $930 demands an answer to that question! But it is not an answer that will be answered in one sentence alone.
It would be foolish to allow simple short-term emotions to make that decision for investors. This particular "Point of Inflection" is critical to the welfare of portfolios, both institutional and private. The decision will be a name-maker or name-breaker.
We at the Gold Forecaster are absolutely certain of that answer, are you?
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Gold Forecaster regularly covers all fundamental and Technical aspects of the gold price in the weekly newsletter.