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January has been a difficult month for
gold, so much so that many market mavens - analysts and investors alike - are
abandoning their bullish expectations.
From its year-end 2010 price near
$1,420 an ounce to its recent low just over $1,320 gold has so far shed some
$100 - about seven percent. Measured from its all-time high just over
$1,432 in early December, the recent decline is less than eight
percent. Either way, in percentage terms, this doesn’t amount to
much of a correction in the metal’s 10-year old bull market.
Bright Fortunes
In contrast to gold’s naysayers
and born-again bears, I believe gold’s fortunes remain very bright.
What’s more, recent market
activity, rather than signaling an end to gold’s decade-long advance,
strengthens the case for a sharp snapback in the metal’s price and new
all-time highs later this year.
Indeed, with gold’s fundamental
price drivers all remaining supportive, I expect another strong advance over
months ahead - with the yellow metal rising to $1,700 an ounce by year-end
2011. While this seems like a lofty target, it amounts to
“only” 19 percent above the recent market lows and is dwarfed by
last year’s 29-percent annual gain and the even bigger 32-percent
advance registered in 2007.
Euro Trigger
Much of gold’s price action in
recent months has been triggered by the ebb and flow of
“safe-haven” funds into and out of the euro.
Whenever Europe’s sovereign debt
problems worsened or the life span of the European currency seemed more
uncertain, a flight of capital and speculative funds out of the euro into
both the dollar and gold - perceived as “safe havens” - gave both
the greenback and the yellow metal a boost. And, whenever sovereign
debt fears subsided, safe-haven demand for the dollar and gold diminished.
Historically, gold and the dollar have
typically moved in opposite directions: Think weaker dollar, stronger
gold; stronger dollar, weaker gold.
But lately, the two have moved up and
down together like Siamese twins - rather than in opposition as history
suggests. We can now see why: Both gold and the dollar are being driven
up and down together as confidence in the euro waxes and wanes.
To the detriment of both gold and the
dollar, a number of developments have come together in recent weeks to boost
euro confidence and push the currency to a two-month high. The list
includes:
- A
spate of better-than-expected economic indicators,
- The
successful refunding of sovereign debt by Portugal and Spain,
- Strong
demand for the euro-zone rescue fund’s first-ever bond issue, and
- Tough
anti-inflation talk from European Central Bank President Jean-Claude
Trichet.
This good news won’t last
forever. Instead, significant economic and social disparities between
the stronger “core” economies (led by Germany and the
Netherlands) and the weaker “peripheral” economies (such as
Iceland, Ireland, Portugal, Spain, and Greece) will continue to threaten the
viability of Europe’s common currency.
Sooner or later another funding crisis
will trigger a new wave of capital flight seeking a safe haven in the dollar
. . . and gold.
Who’s Selling .
. .
To understand where gold prices are
headed this year, its important to recognize that most of the selling in recent
weeks has come from U.S. and European short-term institutional traders and
speculators - banks, trading firms, commodity funds, and hedge funds -
operating mostly in derivative markets, some simply taking profits, others
betting on the downward momentum of the market, and many reacting to the
reversal of “safe-haven” funds that late last year sought
security in U.S. dollar assets and gold.
These players have no long-term view of
gold and certainly no allegiance to the metal as an inflation hedge, store of
value, portfolio diversifier, insurance policy, and traditional savings
medium. They simply sense a profitable trading opportunity. Today
gold is in their sights. Tomorrow, it may be petroleum, cocoa, rice,
steel or long-term U.S. Treasuries. And, one day they will be buying
gold again.
. . . And Who’s
Buying
In contrast, strong physical demand not
only continues but may very well have picked up as lower price levels
attracted bargain hunters. Much of the buying has come from Asian
markets - China, India, and other countries where gold has great cultural
appeal as a store of value, savings medium, and harbinger of good luck and
prosperity to those who hold it.
Big premiums (over New York and London
prices) on gold bars in Hong Kong, Mumbai, and other gold-trading centers
across the region indicate a shortage of physical metal as refiners struggle
to meet strong demand for the various bar sizes popular in the Asian markets.
It is also likely that some central
banks are taking advantage of the current price decline, quietly adding to
their gold reserves or accelerating their purchases. Likely buyers
include the People’s Bank of China, the Bank of Russia, and possibly
one or more of the reserve-rich oil-exporting countries.
In fact, all of the central banks that
have bought gold in recent years today remain significantly underweighted in
gold. All still hold the lion’s share of their official reserves
in U.S. dollar securities . . . and all have an incentive to buy gold on
major price declines.
Strong Hands
Significantly, this dichotomy between
buyers and sellers means that gold is moving into very strong hands and much
of this metal is unlikely to come back to the market anytime soon.
Buyers in Asia are mostly long-term
holders, often for a lifetime. Similarly, many of the retail and
wealthy buyers of bullion coins and small bars in America and Europe are
motivated more by fear than by greed and are likely to retain their physical
gold holdings for years to come.
As a result, when the current wave of selling
abates, gold will have the potential for a swift and sizable recovery - all
the more so if these same players view the metal as an attractive vehicle for
trading and speculation on the long side of the market.
Jeffrey
Nichols
NicholsonGold.com
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