Golden time for GOLD

Gold is on the rise after months of sluggishness.

After all, it’s been almost a year since the $1900+ record high was reached, yet the gold price hasn’t declined even 20%. Think about it… considering the 170% gold rise (from the 2008 low to the year ago record peak), gold has only given back 19+%.

Gold’s strength reinforces the reality of an unbalanced financial world.

Accumulation time is drawing to a close, but it’s still not too late to buy new positions.

Gold will now look promising by staying above $1630, but it’ll be clearly out of the woods above its 65-week moving average at $1650. How high could gold go?

GOLD TIMING: Bottom in & poised to rise further

Many of you know the ins and outs of favorite intermediate indicator.

This is pretty technical. But if you follow along I think you’ll agree that this indicator helps measure the timing and growth potential for each intermediate gold rise, as well as the declines. It’s worked well over the years, including during the bull market of the 1970s.

Bear markets also have these intermediate moves, but with subtle differences.

Gold is a cyclical market and its moves tell us a lot about the world and other markets. Right now, it’s telling us the 11 year bull market is alive and doing well.

SO WHERE ARE WE NOW?

Here’s a twist and some food for thought…  Gold fell from its September record high almost a year ago and it declined nearly 20% to its December low. This fall alone could’ve been a D decline because the indicator fell to the low area and gold tested its moving average.  The percentage decline was also in line with former D declines.

Then the 16% rise to the February high was within reason for an A rise, while the 14% decline from the February highs to the recent May lows was also normal for a B decline.

If this proves to be the case, and the B low is complete, then gold is getting ready to take off in another C rise. And if the bull market stays true to form, we’ll see a record high reached before the leg up is over!

Once gold closes and stays above $1650, we could see it jump up to the $1700 level. Above $1700 means $1800 would be the next target.

If gold rises in a C rise, similar to the 2006-2008 C rise, gold could then reach record highs near the $2200 – $2400 level.

An Ending Made For Gold - Golden

Over the past several months, the markets have tested investors’ conviction to gold. Since February, the price of the yellow metal has steadily stepped lower, rallying somewhat in May before falling again when Ben Bernanke disappointed by not providing the U.S. with more stimulus. Meanwhile, the dollar gained ground as global investors fled the euro.

In the ongoing eurocrisis, we won’t know the details of how Europe will clean up its debt mess for a while, but we’re pretty confident the story ends well for gold.

In one possible outcome presented by Bank of America-Merrill Lynch, austerity is “not the answer on its own” when it comes to restoring confidence in fiscal policies. Take a look at the levels of household and bank debt in the U.S. compared to Europe. Over the past few years, debt in the U.S. has decreased as the private sector has delevered.

In the eurozone, though, you’ll see that banks and households have maintained status quo when it comes to their levels of debt. On all three measures, loan/deposit, household debt/disposable income and debt/income, ratios have remained around the same level, according to BofA.

BofA’s economics team says that even though the long-term refinancing operation (LTRO) has helped in Europe, about 1.7 trillion euros are required to deleverage all the banks in the region. That means there’s more work to be done for Europe via a major deleveraging process, which will undoubtedly weigh on economic growth. To keep the eurozone’s head above water, more money will likely be needed, requiring the European Central Bank to start up its printing presses similar to what we saw in the U.S. over the past few years.

As gold bugs know, when central banks increase the supply of money, currencies become devalued and investors seek a better store of value. The excess liquidity in the market has historically found its way to riskier assets, benefiting gold.

This currency devaluation is what we believe will eventually bring Indians back to gold. Take a look at what gold costs in rupees. India has seen ongoing weakness in its currency as its economy has slowed. This has kept gold near record highs, causing the Love Trade in India to stumble.

The global easing binge from central banks around the world over recent months should have translated to higher commodity prices. This has not occurred: Not only has gold declined, but the price of oil has also decreased considerably, falling from a high of $110 to $78. "Shouldn’t all this accommodative policy by the Fed, ECB, SNB, BoE and BOJ be sending commodities to the moon?”

Lower commodity prices should be a signal to central banks that they are not doing enough.There is a hefty disinflation trend developing and given the amount of debt in the system—and the weakness of global aggregate demand—any signs of significant disinflation should be cause for grave concern. We cannot mix a lot of debt with a lot of deflation—that will be the end of us.

How Gold Demand Remains Resilient

Demand for gold was relatively resilient in the first quarter of 2012, with global demand falling 5 percent on a year-over-year basis, says the World Gold Council. Marcus Grubb, managing director of investment, calls this slight quarter decline in demand “noise in the context of 22 percent rise” in the price of gold compared to first quarter of 2011. Also, gold demand was very strong in the first three months of last year.


Gold faced a complex quarter, as you can see by looking at jewelry demand by country. There was a significant rise in demand for jewelry from Russia, Egypt, Indonesia, Taiwan, and China, according to the World Gold Council (WGC) compared to the first quarter of 2011.

Demand from Russia, which increased 28 percent compared to the same time last year, not only reflects stock building, but WGC says consumers had the wind behind their backs, with “historically low inflation, GDP growth, improving consumer confidence and real wage growth.”

The WGC says that Taiwanese jewelry demand was driven by “a strong wedding season, Chinese New Year gifting and gifts for babies born so far during this auspicious Year of the Dragon.” Indonesia’s increase also most likely reflects Chinese New Year, as retailers replenished supply after a strong buying season.

And, for the second quarter in a row, overall Chinese demand was higher than Indian demand, confirming China as the world’s largest gold market, says Mr. Grubb. China’s demand in the first quarter hit a record, bucking “the global trend by surging 10 percent to reach a new quarterly high” equating to 255 tons, according to the WGC.

Strong jewelry demand was offset by several other countries, including India, which was  negatively affected by imposed taxes and jewelers’ strikes. This caused an “unsettling quarter” for the country, says the WGC, which has historically seen strong jewelry demand over past quarters.

The higher price of gold likely caused a temporary setback in demand in countries such as South Korea, Saudi Arabia and Turkey. The WGC says South Korean consumers substituted silver and lower-carat gold as a result of increased prices.

What’s important to note is that during the past few years of the bull market for gold, we’ve seen continued resiliency in jewelry demand, remaining around 50 percent of total demand, says the WGC.

Gold supply remains modest, as mine production and recycled gold supplies increased 5 percent on a year-over-year basis. Mine production alone increased only 2 percent over the previous year, says the WGC, which follows the trend over the past four years. Mr. Grubb says he sees the trend continuing that older mines in South Africa are declining in production, and the higher-than-average production is coming from China, West Africa, Turkey and parts of Asia.

Overall, Mr. Grubb believes a high level of recycling is required as mine production only meets 2,800 tons of demand. Total demand for gold in 2011 reached 4,500 tons! The only way to balance the supply with the demand: keep an elevated gold price.

Major Bottom in Precious Metals Could Occur This Week

Normally catching a bottom is not difficult. Bottoms tend to occur instantly while market tops form during a process. Yet, I’ve found that bottoms of long-term significance do not occur instantly. Like tops, they take time to develop. For example, think about late 2008 to early 2009. Commodities hit their price low in December but the bottoming process began in October and wasn’t complete until May. Emerging markets hit their low in November but the process began in October and ended in March. Returning to the present, I see that Gold and Silver look set to retest their late December lows. My work lead me to argue that the metals will successfully retest their lows and soon emerge from what in the future will be considered a major bottom in-line with 2008, 2005 and 2001.

I began with a daily chart of Gold which shows its daily closing prices and a volatility indicator. The percentage figure refers to the percent bullish reading from the daily sentiment index. As I noted recently, each bottom in Gold (except 2008) has come during a period of low and declining volatility. Volatility is currently at a 9-month low while only 7% of traders are bullish on Gold.

Next, let’s take a look at the current Commitment of Traders Report (COT) for Gold which shows the commercial short position and open interest at the bottom. The current commercial short position has reached a 3-year low while open interest recently touched a two and a half year low.

Moving to Silver, I see the metal is nearing significant support at $27. Silver closed at $28.93 and has a bit of room to fall before testing $27 and the 600-day moving average, which has been an important pivot point since late 2008. The current daily sentiment index is 16%. I think, with another day or two of weakness in Silver, the daily sentiment index would decline to single digits. I also want to note that $26 is the 50% retracement of the entire bull market.

Silver, unlike Gold, has seen more interest recently as open interest has increased since late last year. However, open interest would have to rise 40% to reach the old high. Commercial traders are net short 17.9K contracts, which is a within a whisker of the 10-year low which was reached at the end of last December. 

Consider these emerging fundamentals with technical analysis. Technicals always lead fundamentals and markets tend to look six to nine months into the future. I am not predicting imminent action from the Fed or imminent money printing from the ECB. However, I am noting the emerging positive developments which will drive precious metals higher into 2013. Policy from the east is shifting towards easy. Europe will have to embark on some major money printing likely by the end of the summer. Finally, continued weakness in US data along with the strength in US Bonds and the US Dollar will facilitate the environment for the next round of Fed action.

I anticipate a bottom this month to be followed by a higher low in July or August. The fundamentals should become more clear by the end of the summer and would drive the precious metals complex much higher during the seasonally strong period. Remember, major bottoms take some time to develop. I believe a bottom is at hand and that is why last week I began to scale into some positions.

What Will Happen to Greece and Gold?

What Greek Elections Now Mean

Greece cannot form a government so expect elections within a month. We have come to the point where the bad news is out –the markets are telling us that Greece will likely leave the Eurozone and possibly the euro as their 10-year debt continues to trade at 27%. They may not pay out €436 million to creditors and keep it, fearing they will not get the next bailout tranche. Reneging on the obligation also would constitute a default triggering derivatives contracts and clauses requiring the settlement of other un-swapped bonds. Meantime the country has no government to make the choice. The country may run out of money by early July. The standoff has reignited concern that Greece will renege on pledges to cut spending as required by the terms of its two bailouts negotiated since May 2010

This blazes the trail for Spain to follow by asking, first, for a bailout. Portugal, Ireland, and potentially Italy are looking more and more each day like Greece. We’re now looking at the worst possible scene.

Whether this will happen or not is not the point for investors in gold and silver. The fact that markets are aware of this situation and are, in fact, discounting it is much more pertinent. If the euro doesn’t collapse and if these nations leave the Eurozone, then do not expect to see the Eurozone fall apart but to be much stronger having jettisoned the weak members. This would strengthen the euro enormously and send it back up towards the €1: $1.40 area. We do not think this is being discounted yet. The old rule that when the news is at its worst is the historic turning point of markets. With gold and silver moving with the euro, traders may keep the precious metals moving with the euro as it rises. This is where we are now.

Consequences in Greece

We have been witnessing a massive flight of capital out of Greece, out of the banks, i.e. Soc. Gen., that are large holders of Greek debt and even Greek money leaving to hide in the stronger member’s banks in the Eurozone. Any exit of Greece from the Eurozone would have to see their banks re-capitalized. Under the Maastricht Treaty, which formed the Eurozone, any member state can impose Exchange Controls for a short period of time while that country remains in the Eurozone. In Greece, that could happen just to close the exits and prevent a further run on the banks.

If the government decides to switch back to the Drachma, then expect to see the steps Argentina took when they switched from the U.S. dollar back to the Peso. These would automatically lead to the changing of all money, deposits and all, to Drachmas.

We would then envisage not just a two-tier currency –one for trade and one for capital. Expect the “Commercial Drachma” to trade at around 50% of the value of the euro and the “Financial’ Drachma” at a 30% discount to that. While this would stall imports, import replacement would spring to life inside Greece and a boom would begin. Tourism would likely roar as cheap holidays drew in huge volumes of tourists.

The central bank would impose draconian exchange controls grabbing all the foreign funds they could. Banks would be eager to return to Greece as they would see a sort of “scheme of arrangement” where they could bring in loans through the “Financial’ Drachma” and, provided the loans were given a 10-yr plus life, would be allowed to repay them through the “Commercial’ Drachma” giving them not just huge capital profits but a boost in their interest earnings over the life of the loan. The resulting low cost of labor and the financial incentives to manufacturers could see manufacturers move production there too. Such a positive outcome for nations that follow this path is normal.

Yes, many in Greece would struggle terribly; however, the core of their financial system would continue, and maybe even thrive.

The success or failure of a Greek exit from the Eurozone and probably the euro would depend entirely on how the financial side of the departure was handled.

It’s well known that Greeks love gold, and rightly so, especially when one considers what lies ahead for them. But they have been buying and preparing for this eventuality for the last two years.

Consequences outside Greece

The Eurozone banking system would suffer tremendous losses and would initially suffer the blows of lost confidence. Again, we’re seeing this now. The overall Eurozone has entered a mild recession that could get worse, but the same could apply to the U.S., travelling some distance behind, in a financial structure more capable of weathering such storms.

The fiscal and political unity in the States is responsible for the current strength of the dollar; however, should the global debt situation worsen and there is a maturing of other major, U.S. problems, then the U.S. will follow Europe; before this happens, however, the emerging world will need to reach the point where it equals the financial world of the developed side of the globe. The Yuan going global would start the process.

We would have to see a rapid expansion of the money supply in Europe as toxic national debt values shrank and needed a fresh injection of capital to replace lost value. We’re on the brink of another chapter of this right now. While this would undermine confidence in the euro and the dollar, the reality that these currencies are the only available means of exchange will continue to ensure their use and control over the developed world.

But the loss of confidence process would result in investors seeking to preserve the value of their wealth in gold and silver bullion even more than we have seen in the last few years. Many times have discussed just how gold would be used to reinforce the current currency system and how that process would become reality. More importantly, the institutionalization of gold in an active role in the monetary system would become a reality.

This would start in Europe, but the U.S. would dovetail into the developments as a cautionary reinforcing of its own monetary system too.

It may be that the public discussion over where Germany’s gold is held will lead to public pressure on Germany to repatriate it. If this happens, expect other nations in the develop0ed world to follow over time, accompanied by the recognition of gold’s importance in the reserves of a nation. This will highlight the desirability of gold in reserves to other nations outside the developed world and an acceleration of the demand for gold by the world’s central banks.

People wonder why gold is not already say $5000

People wonder why gold is not already say $5000 (it certainly could be) right now, given the fact that the US Fed alone and the US treasury have either given directly or bought (or guaranteed) up to $20 trillion USD worth of world bad debt/bonds/CDS/derivatives, you name it. That money went to US and European and other world banks and financial institutions into a literal rat’s nest of opaque levered multilayered contracts and leverage…


Jumping ahead

It would seem that the gold price should simply reflect all that money that was thrown out there, no? Answer at this stage? No.

Ok if all that incredible amount of money (and we are only talking the Fed at the moment, not the Chinese, the Japanese, nor the ECB all with say at least another close to ten $trillion USD worth, meaning in their own currency but we just use the USD to compare the amount here) they all threw into the flames….

Flames is a good analogy. What happened is this…They are attempting to keep alive a world awash in debt and all that money is merely being used to cover huge losses at financial institutions…which are basically like zombie banks now…and all the while the public funds are being depleted at a rapid rate.

Ultimately at the end of the day, all those trillions, which would have been far better spent say, paying off the total of US mortgage debt, like Iceland did, which would have caused a total resurgence of the US economy.

But they threw this money where it would not reach the general population. And since the general population is who accounts for the 70% of US GDP – i.e. consumption, and not only a few millionaires and billionaires, all that money was wasted…. Thus, clearly that money was literally burned, but with the cost of levering all the public governments and ultimately will cause interest rates to rise drastically. Ultimately. But the US has some time yet….
 


Phase Two

Phase one is debt deflation and money destruction. Gold is representing this situation perfectly, merely reflecting the inflated price of gold since (I am picking a date here) of about a 3 to one price hike in all goods and services (or make it 4 now) since 1980 when gold peaked at say $870 then dropped after Volcker raised US interest rates briefly to roughly 20 pct. which slammed US inflation which started in earnest after the oil shock…We have already discussed what phase one of a debt crisis does above. Let’s discuss Phase Two…I know these paragraphs are a bit dense but I like to write short concise stuff at times.

In Phase Two, after the central banks have realised that they have attempted to monetise the entire book value of the world markets (Probably Greenspan’s Gambit which is not well understood, where he stated he wanted to fight the next Great Depression, and probably thought he could simply monetise the markets in total and do a restart without an economic collapse) they will then have to start simply massively increasing public assistance and or direct aid to the rebelling and suffering populations. At this point, inflation starts up again and interest rates start rising, rapidly. In this scenario the UST rate could jump from say 2 pct. on the US ten year, to 5 in a matter of months or one year. Gold at that point will double.

Inflation will start to appear in all things, particularly oil and food. A sort of downward spiral which is self reinforcing will further contract the economy, the attempts to maintain all debts of all kinds will fall by the wayside, and people will focus on shelter and such only. The same will go for the public sector debts.

How close we are to phase two, and gold spiking to first say a jump from $2000 to $4000 is hard to say. But gold is headed there. In the meantime, the world is caught in an economic debt deflationary cycle, and until phase two is reached will meander between $1500 and $2000 for 2012, with the exception that a Mid-East war would probably spike oil, and possibly gold over $2000. But gold has a few problems there because oil price hikes cause economic contraction so that is a bit complicated.

Anyway, I have forecast gold to range from $1500 to $2200 for 2012 back in 2011, and have been right.

Record High Gold Prices Fail to Curb Global Demand

Despite a volatile year for gold prices in 2011, demand for the precious metal still remained strong. According to the latest World Gold Council’s annual report, gold demand totaled 4,067.1 tonnes, a slight increase from the prior year. Record low interest rates, inflation expectations and investment demand continued to drive the gold bull market.

The annual value for gold demand in 2011 equalled $205.5 billion, an all-time high and a 29 percent gain above the 2010 value. Jewellery accounted for $99 billion in gold demand, while investment demand was close behind with nearly $83 billion.  Interestingly, the majority of investment demand value was due to physical bar and coin demand, which represented $75 billion. As more investors remain sceptical and lose confidence in the global financial system, they turn to physical gold for protection. The annual report explains, “The bar and coin story is one which has traversed borders led by China, India and Europe, but other markets have also participated in terms of relative growth rates. Store of wealth demand, diversification, negative real deposit rates, the threat of inflation in developing markets, deflation in developed markets and currency debasement have all contributed to driving up demand over the last few years.”

In 2011, the average price of gold averaged $1,571 per ounce, which was more than 28 percent higher than its 2010 equivalent. While this contributed to the record annual value for gold demand, it also proved an argument against gold to be incorrect. Many gold critics claim that as gold prices increase, the supply of gold will also increase from people selling any form of gold they might hold. However, this is simply not true.  Despite a nominal record high of $1,900 per ounce, recycled gold declined by 2 percent. In fact, recycled gold supply has been declining since 2009, when it hit a peak of 1,694.7 tonnes. The WGC explains, “Despite the rise in prices, recycling activity was constrained by a combination of expectations for higher prices, acclimatisation to a higher current price level, economic growth and exhaustion of near-market supply.”

Record high gold prices also failed to significantly curtail the appetite for industrial demand. The technology sector demanded 463.5 tonnes of gold in 2011, down from 466.4 tonnes in 2010, but still above the 456.3 tonne average of the preceding five year period. Within the sector, electronic demand increased from 326.9 tonnes in 2010 to 330 tonnes in 2011. The dental segment is the one area that appears to be affected by rising gold prices. Dentistry gold demand fell 10 percent year-over-year to 43.8 tonnes. The WGC reports, “This result was driven by the elevated gold price and weak economic conditions which continued to encourage substitution both in favour of palladium and non-precious options, mainly cobalt-chrome and ceramic materials.”  However, dentistry represents a small portion of global gold demand, and will not have a material impact on prices.

Even though 2011 was filled with volatility and higher gold prices, the world still craves the only world reserve currency that can not be printed. The current trends that have fuelled the 11-year gold bull market remain in place. Furthermore, gold prices continue to receive additional support as central banks not only devalue fiat currencies, but also purchase gold themselves. “The net buying trend which started in Q2 2009 has proliferated, as emerging market central banks have continued to add gold on increasing concerns about the creditworthiness and low yields of their existing reserve assets. Both the euro area sovereign crisis and the sovereign debt downgrade in the US during the summer of 2011 have compounded these worries,” states WGC.  In the past two years, central banks have purchased more than 500 tonnes of gold.

In the Bullring With Gold

 

After prices fell 10 percent in December, many investors wondered if the bull market in gold was running out of steam. That was before Federal Reserve Chairman Ben Bernanke swooped in with a “red cape” and fired the bulls back up. Since the Fed reassured the world that interest rates will remain at “exceptionally low levels” for another two years, gold has jumped more than three percent.

UBS described the situation simply, “if investors needed a (further) reason why they should be long gold now, they got it yesterday … a more accommodative policy is a very good foundation for gold to build on the next move higher.”

To gold bugs, two more years of near-zero, short-term interest rates means negative real interest rates are here to stay, and this has historically been a strong driver for higher gold prices.

Bernanke and the Fed aren’t the only central bankers in the fiscal and monetary bullring. Brazil has cut its benchmark interest rate a few times and China lowered its reserve rate for banks in December. According to ISI Group, 78 “easing moves” have been announced around the world in just the past five months as countries look to stimulate economic activity.

One of the main weapons central bankers have employed is money supply, which has created a ton of liquidity in the global system. Global money supply rose 8 percent year-over-year in December, or about $4 trillion, according to ISI.China experienced a record increase in the three-month change in M-2 money supply following China’s reserve rate cut.

Together, negative real interest rates and growing global money supply power the Fear Trade for gold. The pressure these two factors put on paper currencies motivates investors from Baby Boomers to central bankers to hold gold as an alternate currency.

Adrian Ash from Bullionvault says global central banks are on a buying spree and they have been since the Fed cut interest rates by 25 basis points in 2007. Central bankers’ shift to buying gold was a significant sea change for the yellow metal.

You can see from the chart below that official gold reserves have historically been much higher, averaging around 35,000 tons. In the 1990s, central banks began selling, with reserves hitting a 30-year low right around the time the Fed began cutting rates. Adrian says that gold holdings are now at a six-year high with the current amount of gold reserves just less than 31,000 tons.

These are countries large and small. In December, Russia, which has been routinely adding to the country’s gold reserves since 2005, purchased nearly 10 tons; Kazakhstan purchased 3.1 tons and Mongolia bought 1.2 tons. UBS says “although reported volumes are not very large, it is still an extension of the official sector accumulation trend.”

 

Not all central banks are recent buyers, though. The “debt-heavy West” has sold its gold holdings, while emerging markets increased their gold reserves 25 percent by weight since 2008, says Adrian.

Reserves as a percent of all the gold mined has also declined, with “a far greater tonnage of gold ... finding its way into private ownership,” says Adrian. Since 1979, you can see the percentage of reserves to total gold has declined at a much faster pace as individuals increasingly perceived gold as a financial asset.

Adrian points to China’s Gold Accumulation Plan as a recent example of this trend. A joint effort between the Industrial & Commercial Bank of China (ICBC) and the World Gold Council (WGC), the program allows Chinese citizens to buy gold in small increments as a way to build up their gold holdings over time. The WGC reported in September that the program had established 2 million accounts during its first few months in operation and the amount is growing by the day.

These programs open the door for gold as an investment to a whole new class of people in China but that’s only a fraction of the tremendous demand for gold that we are seeing from China. In addition to the Fear Trade, gold is driven by the Love Trade, which is the strong cultural affinity the East, namely China and India, has to the precious metal.

In 2010, the Indian Sub Continent and East Asia made up nearly 60 percent of the world’s gold demand and 66 percent of the world’s gold jewelry demand, according to the WGC.

Indian jewelry demand has historically increased during the Shradh period of the Hindu calendar, but last year, high prices and a volatile rupee kept many Indian buyers on the sideline.

If you thought $1,900 was too much to pay for an ounce of gold, imagine how Indians felt when the rupee fell against the U.S. dollar, causing a gold price spike in rupees. Gold in Indian rupee terms rose more than 35 percent from July to November, roughly three times the magnitude of gold priced in U.S. dollars, yuan or yen. This currency swing significantly impacted Indian gold imports, which dropped 56 percent in the fourth quarter, according to data from the Bombay Bullion Association.

 

“Indian buyers will be back” after they adjust to the higher prices, says Fred Hickey. In one of his latest editions of “The High-Tech Strategist,” he cites late 2007 as a recent example when the Indian gold market experienced a similar rough patch. That year, gold demand in India fell off a cliff after prices spiked more than $1,000 an ounce in one quarter, tarnishing the country’s love affair with gold for a “brief period.” Fred says their cultural affinity for gold as an important store of wealth and protection against inflation will drive Indian buyers back into the market.

The trend was already changing in 2012, as UBS reported that the first day of trading saw physical sales to India were twice what they usually are, according to Fred. Although this is a very short time frame, I believe the buying trend will continue in this gold-loving country.

In China, “just as in India, gold is seen as a store of wealth and a hedge against inflation,” says Fred. Demand has been growing, especially in the third quarter, when China’s gold purchases outpaced India. “Physical demand for gold from the Chinese has been voracious all year,” says Fred. As of the third quarter, China had already obtained 612 tons, eclipsing its total 2010 demand, according to the WGC.

Across the Chinese retail sector, gold, silver and jewelry demand was the strongest performing segment in 2011, says J.P.Morgan in its “Hands-On China Report.” Growth in this segment far outpaced clothing and footwear, household electrical appliances, and even food, beverage, tobacco and liquor, all of which experienced more modest growth.

 

J.P.Morgan says the bulk of the increase came from lower-tier cities “where income levels are rising the fastest and improvements in retail infrastructure have allowed for rapid store expansion.”

Increasing incomes coupled with government policies that support growth have been the main drivers for rising gold prices. Take a look at the chart below, which shows the strong correlation between incomes in China and India and the gold price. As residents in these countries acquire higher incomes, they have historically purchased more gold, driving gold prices higher.

It is anticipated that the Year of the Dragon would spur an increase in the buying of traditional gifts of gold dragon pendants and coins. Gold buying did hit new records, says Mineweb, with sales of precious metals jumping nearly 50 percent from the same time last year, according to the Beijing Municipal Commission of Commerce.

This should serve as a warning to all of gold’s naysayer. Gold bullfighters beware—you now have to fight the gold bull while fending off a golden Chinese dragon.

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.