Despite the winding down of East Asia’s Lunar New Year gold buying binge, I expect the yellow metal’s price will continue to move up in the weeks ahead – but not without some struggle as gold works to reestablish upward momentum and renewed credibility.
Historically, with the arrival of the Lunar New Year, gold demand and the metal’s price typically enter a seasonally weak period – but the typical seasonality is no longer a reliable guide to gold price prospects.
The usually weak summer months this past year saw gold run up to new historic highs above $1,900 an ounce . . . and, contrary to expectations, the seasonally strong autumn months saw gold prices fall sharply, all the way back down to $1,525 or thereabouts.
Changes on the Demand Side
Now, with winter upon us, I don’t expect gold prices will drop with the temperature as they often have at this time of year. Instead, I believe that there have been important changes on the demand side of the gold market that now overpower or outweigh any remnants of seasonality.
For one thing, institutional investor participation has grown by leaps and bounds, as has retail demand for bullion coins and small bars.
Similarly, official-sector gold accumulation has become an extremely important non-seasonal factor effectively removing several hundred tons of gold from the market in each of the past two years.
I expect central bank demand not only to continue but possibly expand in 2012 with China and Russia leading the pack – and a growing number of countries underweighted in gold relative to US dollar-denominated reserves joining in this official-sector gold rush.
These buyers – private investors and governments alike – don’t care what the weather is. Instead, their behavior is a reaction to macroeconomic and political developments in their own countries and around the world without regard to the time of year.
And, institutional traders and speculators – who lately account for much of the short-term volatility in the metal’s price – are often governed by new and changing trading modalities and algorithms.
For example, the increased importance of “portfolio rebalancing” by index, commodity, and hedge funds has, for now, introduced a new element of seasonality, one that weighed heavily on gold in late December and early January when many of these funds were large-scale sellers of gold, mostly in futures and other derivative markets, but nevertheless with negative price consequences that are now past.
Shrinking Free Float
Continuing Chinese gold accumulation has important long-term significance that is not generally acknowledged by many gold analysts and market pundits. Simply put, China’s private-sector gold purchases are unlikely to be sold back to the world market any time soon, certainly not for many years to come and even at much higher prices.
Not only are gold exports from China illegal – but many, if not most, Chinese savers and investors buy gold with no intention of selling sometime in the future just because prices rise, inflation subsides, equity prices tumble, or any of the other drivers that might trigger sales by Western investors. For the Chinese, these are long-term, quasi-permanent holdings.
The same can be said of central-bank gold purchases, not just by the People’s Bank of China, but by most of the central banks that have been building gold reserves in recent years.
As a result, the supply of available gold in the marketplace – what I call “free float” – is diminishing . . . and any pickup in gold demand for jewelry, investment coins and bars, official reserve accumulation, etc., will have a more high-powered affect on the metal’s price than might have been the case a few years ago.
More Money Will Fuel Gold’s Ascent
Prospects of further monetary easing by the world’s three top central banks – the US Federal Reserve (the Fed), the European Central Bank (the ECB), and the People’s Bank of China (the PBoC) – also know no season and are also becoming more supportive.
In each region, signs of slowing economic activity, unacceptable or worsening labor-market conditions, and continuing restrained consumer price inflation suggest that central banks will press harder on the monetary accelerator in the months ahead.
As in the past, quantitative easing or other steps to raise credit availability by the Fed, the ECB, and the PBoC could fuel surprisingly big moves in the price of gold in the months ahead.
Finally, there are a number of “wild cards” that may affect gold prices – for better or worse – in the days and weeks ahead. At the top of my list:
- America’s political log-jam and Washington’s inability to reach a consensus on important federal debt and budget measures;
- Heightened tensions in the Middle East - with saber-rattling by Iran, oil-price uncertainties, approaching Egyptian elections, and the threat of civil war in Syria;
- Europe’s continuing sovereign-debt crisis, further downgrades by the credit-rating agencies, the looming Greek default and departure from the euro-zone, possibly followed by other deeply indebted countries.
- And, perhaps most importantly, how the US dollar reacts in world currency markets to any of these unfolding developments and to further monetary easing by the US Fed.
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.