Gold hit a fresh three-year low of $1,180 per ounce in late June and has since struggled back to the $1,240 to $1,260 range. Although the latest decline began back in April, the sell-off accelerated in June following Fed Chairman Ben Bernanke’s statement that the U.S. central bank might soon taper off its program of quantitative easing.
Although the price of gold remains vulnerable and overly sensitive to any bearish news, the metal’s price is, in my view, already in the process of bottoming.
Risk vs. Reward
At recent price levels, the probability of a sizable and sustained decline (of, say 15 to 20 percent) seems considerably less than the probability of a similar long-lasting percentage advance. Moreover, should we see another round of price weakness, even below the June low point, it is very likely to be short-lived . . . while a meaningful advance would signal the resumption of gold’s long-term bull market.
In fact, many gold investors and suppliers of bullion coins, small bars, and investment-grade jewelry are already sensing that gold has found a bottom after the steep decline of the past few weeks. In response, physical demand and dealer restocking across Asia have already picked up, a sign that a rally in the price of gold may already be underway.
Similarly, we suspect a few central banks - most notably the People’s Bank of China and the Central Bank of Russia - may have recently resumed or accelerated their long-term gold acquisition programs.
Physical gold markets, which in the past couple of years have been losing the tug of war with paper markets, may now be on the ascendency, regaining their influence in setting the metal’s price. While Western gold traders and institutional speculators have been selling, Eastern investors and central banks have continued to accumulate physical bullion.
Shortage Begins to Bite
Importantly, these are long-term buyers many of whom are unlikely to part with their recently acquired gold at any price - and this is now creating a shortage of actual metal to satisfy new physical demand - what I’ve called “free float” in past reports.
This shortage accounts for the significant price premiums now prevailing over the benchmark London and New York gold-market prices). Indeed, buyers in China are now paying as much as $40 an ounce an ounce above the London benchmark.
Another often-overlooked indicator of physical market supply and demand is the wholesale gold lending (or leasing) rate. This is the interest rate bullion dealers, banks, central banks, and large institutional gold-market participants charge one another to borrow physical gold. In the past few days, the one-month gold lending rate has risen from little more that one-tenth of a percent to more than three-tenths of a percent.
We have long argued that this scarcity of physical gold may result in a surprisingly high-powered advance in the price of gold when institutional selling has run its course and Western market psychology sheds its extreme negativity.
