From its mid-October all-time high pennies over US$1,387 to its recent low just under $1,315 last Friday, gold suffered a loss of just about 10%. However, looking closely at the price action and short-term supply/demand flows of recent weeks reveals the metal's inherent strength - and, in fact, raises our confidence that gold prices are headed much higher over the next few years.
Following a pattern that has become fairly routine and that characterized previous corrections in the past couple of years, much of the selling in recent weeks was concentrated in derivative markets as institutional traders and speculators took profits following the steep price advance. Importantly, once again, as world gold prices declined, stronger physical buying emerged in the key Asian markets led by India and China - physical buying that effectively established a floor price.
It is noteworthy that this recent bout of Western selling and Eastern buying has moved gold from weak hands to strong, from traders and speculators with no lasting allegiance to the metal except as a short-term trading vehicle to savers and hoarders, many of whom will hold this metal for years to come - and some of whom will never sell, choosing instead to pass their holdings on to their future heirs.
At the same time, much of gold's recent sound and fury, both on the way up a few weeks ago and the subsequent decline, can be explained by the flow of announcements about US and global economic-policy prospects, particularly news about US monetary policy and the US dollar.
Rising expectations of further US monetary easing with talk by policymakers and private-sector economists of another round of quantitative easing, faster growth in money supply, raising inflation targets and intentional dollar devaluation fueled gold's steep ascent from record high to record high over the past few months.
Then, in the run up to last weekend's meeting of Group of Twenty (G-20) finance ministers and central bankers, some traders and speculators, worrying there might be an imminent announcement of international cooperation on domestic monetary policies and exchange-rate targeting - and sensing that the metal's latest advance was stalling - decided to play it safe and book profits on long gold futures market positions.
Now, with the G-20 meeting of finance ministers and central bankers behind us without any meaningful agreement to avert currency wars, exchange-rate instability, and competitive devaluations, gold is recovering.
However, there are three developing news stories that could create more gold-price volatility - up or down - in the weeks ahead:
- First, the US mid-term election on Nov. 2 - and its implications for prospective US monetary and fiscal policies.
- Second, the Federal Reserve policy-setting meeting next Monday and Tuesday - and the expected announcement about quantitative easing and inflation targeting.
- Third, the Group of Twenty meeting of heads of state on Nov. 11 and 12 - and any more believable signs of international cooperation to manage exchange rates and lessen global economic imbalances.
We suspect that each of these unfolding stories will support our expectations of further U.S. monetary ease and - together with gold's other solidly bullish fundamentals - will push the yellow metal's price to new record highs by year end.
Jeffrey Nichols, managing director of American Precious Metals Advisors and senior economic advisor to Rosland Capital, has been a precious metals economist for over 25 years.