The Gold Triple Play - Volatility, Currencies and Europe

Resurgent investment lifted global gold demand 6 percent from the previous year to just over 1,000 tons during the third quarter of 2011, according to the latest Gold Demand Trends Report from the World Gold Council (WGC). The ­­­potent cocktail of inflationary pressures in the emerging world and the European sovereign debt fiasco left investors searching for a safe haven—they looked for it in gold.

In an uncertain era where many asset values are declining, gold has thrived. Gold prices averaged $1,700 an ounce during the third quarter of 2011, 39 percent higher than the same time last year and 13 percent above the previous quarter, according to the WGC.

 

 

While investment demand thrived during the third quarter, jewelry demand fell victim to the quarter’s economic fragility and price volatility—falling 10 percent on a year-over-year basis. Only four markets—China, Hong Kong, Japan and Russia—saw jewelry demand increase.

The WGC says a shift toward high-growth economies is “undeniably conspicuous in the gold market.” Nowhere in the world is this more evident than in China, where consumer thirst for gold appears unquenchable. China’s total demand, around 612 tons year-to-date, has already eclipsed that of 2010. In addition to domestically consuming every speck of gold mined in China, it’s estimated that the country’s gold imports could reach 400 tons in 2011. That’s roughly equal to the combined tonnage of gold demand for the Middle East, Turkey and Indonesia in 2010—and that’s just imports.

Consumer demand for gold in China increased 13 percent (year-over-year) during the third quarter as the country continues to close the gap on India. Chinese jewelry demand, also up 13 percent, eclipsed India for only the fourth time since January 2003. Combined, the two Asian giants account for over 50 percent of global jewelry demand.

The WGC says, “China’s increase in demand is being fueled by rising income levels, a by-product of China’s rapid economic growth.” This growth has given birth to more than 100 million gold bugs in China’s rural areas. China’s smaller third- and fourth-tier cities were responsible for the bulk of the increase in jewelry demand, the WGC says. In addition, the Gold Accumulation Plan (GAP), a joint effort from the Industrial & Commercial Bank of China (ICBC) and the WGC which allows investors to purchase gold in small increments, reached 2 million accounts in September. The WGC says GAP sales have already exceeded 19 tons so far this year.

Things weren’t quite as rosy for demand in the world’s second-largest jewelry market. Indian jewelry demand took a 26 percent hit as volatility in the rupee shook investor confidence. The rupee decreased 9 percent against the U.S. dollar during the third quarter, more than double the currency’s average quarterly move over the past five years.

Historically, Indian jewelry demand bottoms in July-August, before picking up heading into the Shradh period of the Hindu calendar. That didn’t happen this year because Indian consumers were discouraged by high and volatile prices. The WGC says:

 “Consumer confidence in India has been knocked by the persistence of high domestic inflation rates. Inflation of almost 10 percent, as measured by the Wholesale Price Index (WPI), adversely affected jewelry demand, through its impact on both disposable income levels and general consumer sentiment.”

Currency Effect on Gold Prices

The weaknesses of the rupee against the U.S. dollar also negatively affected India’s demand. This chart illustrates the dramatic effect currency fluctuations can have on gold prices.

 

The gold price in Indian rupees has appreciated over 31 percent since June 30, more than three times the price appreciation denominated in Japanese yen. This means that a consumer looking to buy gold in Japan would have three times the purchasing power to buy gold at their local dealer than an Indian counterpart.

The gold price in yen terms has lagged due to the currency’s strong appreciation against other global currencies. It’s a similar story for the U.S. dollar and Chinese yuan (pegged to the U.S. dollar), which investors have favored since fleeing the euro.

Gold’s Volatility

Chaos in the currency markets amplified gold’s volatility to roughly twice historical levels during the third quarter, the WGC says. Our research also shows that gold’s recent roller-coaster ride is an anomaly. We sorted through 10 years of data to capture all of the 10 percent (plus or minus) moves selected assets have had over a one-month period. The results show gold experiences plus/minus 10 percent moves 7 percent of the time; about the same as the S&P 500 Index. In comparison, crude oil sees moves of this magnitude 30 percent of the time.

 

Gold equities have been more volatile than gold bullion. The NYSE Arca Gold Bugs Index (HUI) experienced these swings 33 percent of the time. In a market with gold prices trending upward, this beta provides a potential boost for miners. However, this can also have a negative effect during volatile markets as investors overreact to downside swings.

Gold and Silver Charts Point to Further Consolidation - Get Ready

Last week’s free fall in both gold and silver spot prices was enough to get investors into a panic. More on this in a minute though...

The fall was triggered by three key factors which caused the powerful move down. The first factor is based on pure technical analysis (price and volume patterns). Because the metals had such a strong run up this summer and prices had moved to far too fast, it is only natural so see price correct back to a normal price level. In general any investment that surges in one direction in a short period of time almost always falls back down shortly after. As I stated in my weekly report on August 31st, “gold is forming a topping pattern and all investors should take profits or tighten protective stops (exit orders)”. Three days later gold popped to the new high completing the pattern and was quickly sold off which continues to unfolding as we speak from $1920 down to $1532 in only a couple weeks.

The second factor which I think had the most power behind the drop were the margin requirements changes. This new rule literally overnight caused traders and investors holding to much of the metals in their account to liquidate (sell) their positions without having any say in the matter. That is when the most damage was done to the price of gold and silver.

The key factor was the US Dollar which rocketed higher and adding a lot of pressure to the metals. I also covered this in my Aug 31st report in detail. Overall, past few years we have seen both gold and silver move in opposite direction of the dollar. I don’t expect that to change much going forward. Back in August the US Dollar was coiling (building power) and it was only a matter of time before it would explode to the up side and rallied. This high probability move in the dollar was what triggered me to exit our long gold positions shortly after. I expected the dollar rally to last a month or more and that means we would see a lot of pressure on equities and metals going forward.

Now keep in mind, if Greece or other countries continue to get worse then we could see the dollar and gold move higher together as they are seen as the safe haven at this time. But with the nature of the two I am anticipating a rising dollar and sideways trading range for gold.

Ok, so back to precious metals investors...



Let’s take a look at the charts...

Silver Spot / Futures Price Chart

As you can see on the hard right edge silver is forming a very similar pattern which happened this past spring. I would like to note that this type of pattern is typical with extreme market selloffs as to how they generally bottom. I am anticipating silver trades in this range for a couple months and that we could see lower prices in the near term. But my upside target for silver in the coming few months is the $35-$36 level.

Gold Spot / Futures Price Chart

Gold is doing much the same as silver but I have noticed that when gold falls hard the second dip generally does not make a new low as often. If we do get a new low, all the better for buying on the dip but overall I feel gold should trade sideways for a couple months. My upside target for gold is the $1750-$1775 area.

US Dollar Index Price Chart

The Dollar index is looking ripe for another bounce and possibly another rally to new highs in the coming week. If this happens then we should see the SP500 short position (SDS) which we took Tuesday afternoon (Sept 27th) to continue rocketing another 5-8% in our favour again.

In short, I feel the US dollar is going to continue higher and that will put the most pressure on stocks, oil and silver. Depending how things evolve overseas gold could hold up and possibly rise with the dollar.

How High Will Gold Go in 2011?

After stellar years for both gold and silver, what prices will precious metals hit in 2011? First, take a look at the annual percentage gains that gold has registered since 2001 (based on London PM Fix closings): Excluding 2001, the average gain is 20.4%. Tossing out the additional weak years of '04 and '08, the average advance is 24.8%. So we can make some projections based on what it's done over the past 10 years. From the 12-31-10 closing price of $1,421.60, if gold matched… The average rise this decade, the price would hit $1,711.60 The average rise excluding the three weak years = $1,774.15 Last year's gain = $1,858.03 The largest advance to date (2007) = $1,875.09 But what if global economic circumstances continue to deteriorate? What if worldwide price inflation kicks in? And what if government efforts at currency debasement get more abusive? Here's what price levels could be reached based on the following percentage gains. 35% = $1,919.16 40% = $1,990.24 45% = $2,061.32 50% = $2,132.40 1979's gain of 125.7% = $3,208.55 It thus seems reasonable to expect gold to surpass $1,800 this year, as well as reach a potentially higher level since the factors pushing on the price could become more pronounced. Here's a look at silver. As you can see, silver had its biggest advance in 2010. The average of the decade, again excluding 2001, was 27.5%. And also tossing out the '08 decline, the average gain is 34.3%. So, from the 12-31-10 closing price of $30.91, if silver matched... The average rise this decade, the price would hit $39.41 The average gain excluding 2008 = $41.51 Last year's advance = $56.22 The 1979 gain of 267.5% = $113.59 So, $50 silver seems perfectly attainable this year.  And that's without monetary conditions worsening. It's titillating to ponder these advances for gold and silver, especially when you consider we might be getting close to the mania. And if we are, that should do wonderful things to our gold and silver stocks, too. I would add one caution: the odds are high that there will be a significant correction before gold begins its march to these price levels. In every year but two ('02 and '06), gold fell below its prior-year close before heading higher. And here's something to watch for: in every year but one ('08), those lows occurred by May. In other words, a buying opportunity may be dead ahead. And if you buy on the next correction, your gains on the year could be higher than the annual advance.