Gold's downside still limited and upside potential great - Nichols
The recent correction in the gold price has been relatively small as corrections go so far and Jeffrey Nichols believes gold's upside potential remains stronger than downside risk.
Posted: Friday , 22 Oct 2010
NEW YORK - -
Having reached an all-time high of US$1,387.35 an ounce on October 14th, some run-of-the-mill profit taking by short-term traders and institutional speculators on world futures markets triggered last week's swift downward correction in the yellow metal's price.
Then, this Monday's surprise announcement by the People's Bank of China that it would soon raise short-term interest rates to combat domestic inflation knocked the price still lower -- not so much because there was more selling but because many buyers paused to reassess the metal's short-term prospects.
Having traded as low as $1,328.30, the correction to date is not as large as headlines and media attention might suggest. All in all, the past week's peak-to-trough decline of $59.05 represented a loss of little more than 4 percent -- not much as corrections go.
Gold is still up more than 20 percent this year -- outpacing equities, bonds, real estate and most other commodities, and, almost certainly, it will rack up its tenth consecutive annual gain.
After the meteoric rise in the past couple of months, a rise that has seen gold achieve new historic highs, it is not surprising to see a modest correction. Indeed, at Rosland Capital, we have consistently warned investors to expect great volatility -- both up and down -- as the yellow metal continues its long-term advance to new record-high prices.
Looking beneath the surface at recent market intelligence suggests that downside risks are limited while key market fundamentals suggest upside potential remains great. Indeed, even if the recent downtrend continues, my confidence in the metal's bright future remains strong. The bullish case for gold not only remains intact -- but looks increasingly more powerful.
In recent weeks, with gold moving from high to high, our friends in India report continuing strong local demand at this important seasonal time of year for the country's annual gold consumption.
The historical experience suggests that high and rising prices not only inhibit Indian gold buying but, at the same time, elicit selling of old gold jewellery, investment bars and working inventory at local bullion merchants and jewellery shops. In recent years, this price-sensitive behavior often capped gold-price rallies in world markets. But in recent weeks, contrary to the historical experience, with prices near their highs, India remained a net buyer of gold. Importantly, in the past few days with gold around $1,330 to $1,340 net Indian demand has picked up smartly.
Two distinct factors are contributing to the uncharacteristic behavior of Indian gold demand:
· First, the approaching Diwali festival on November 5th and the traditional December wedding season are propitious times for buying gold -- as an investment, as an adornment and as a wedding dowry -- and merchants have begun stocking up.
· Second, a large share of Indian gold interest comes from the agrarian sector -- and this year's bountiful harvests, high agricultural prices and resulting healthy farm incomes mean that more money is available to buy gold.
Friends in Vietnam and Thailand, both important gold-consuming markets, also report continuing strong demand in the past couple of months -- and we hear local buying picked up as gold prices fell back in the past week.
Turning to China, arguably the world's most important national gold market of late, we have seen buying interest -- for both jewellery and investment -- continue to grow and, indeed, expand in recent months as the metal's price has moved higher.
In contrast to India, where rising prices often restrain demand, Chinese buyers, not wanting to miss the opportunity, are attracted by a rising price trend. But not to miss a bargain, we hear from Shanghai that there has also been strong interest as the price moved into reverse last week.
Longer term, demand for both jewellery and investment has a strong correlation with growth in personal income. As more people enter the middle class and enjoy some disposable income beyond the necessities of life, one of the first things people will buy is gold, and, over time, the more household incomes rise, more of this money will find its way into gold.
In this light, this week's news that China's central bank is beginning to raise interest rates in response to rising domestic inflation should be seen as a positive for gold.
Over time, rising incomes are much more supportive of gold consumption than accelerating inflation. Government policies that promote healthy but not excessive growth in national output -- and avoid an unsustainable overheated inflationary boom -- will also prove positive for the continuing expansion of the domestic gold market and a rising price for the metal in world markets.
China and India aren't the only reasons to expect a quick resumption in gold's upward ascent. A growing number of countries have been adding to their official gold reserves in order to reduce the risks associated with their U.S. dollar-denominated holdings.
Official central bank interest in gold is gaining momentum -- with China, India, Russia, Mauritius, Sri Lanka, the Philippines, Kazakhstan, Venezuela, Saudi Arabia, Bangladesh and Thailand reporting gold purchases in the past year or two. Now, South Korea is reportedly considering joining the list of central bank gold buyers. Add to this at least a few other central banks and sovereign wealth funds that have bought gold but have so far preferred not to publicize their purchases.
Most central banks take a very-long term approach to management of their official foreign currency and gold reserves. Those with on-going gold-buying programs, rather than chase a rising price, typically buy on dips in the hope of minimizing their long-term average purchase price. Thus, it is likely that official-sector demand -- from Russia, China, and possibly a few other central banks -- has also been a factor in recent days, limiting the correction and contributing to the recovery in the price of gold.
Jeffrey Nichols, is Managing Director of American Precious Metals Advisors and Senior Economic Advisor to Rosland Capital, and has been a leading precious metals economist for over 25 years.