Rate Cuts Could Cause Rebound in Gold Price

July 12, 2013 at 08:38


No market moves in a straight line and, more often than not, fluctuations tend to overshoot both on the way up as well as on the way down.
It appears that this has happened to the price of gold over the last 93 weeks since its peak in September 2011.
The interesting aspect of this downturn is that it has lasted longer and has been much sharper than the previous three major corrections in gold’s 12-year uptrend.
It is also noteworthy, as recorded in the table below, that corrections have become progressively longer and deeper as the price has moved to higher levels.
Starting year of correction in gold price 2003 2006 2008 2011
Approximate duration of weakness (weeks) 29 68 75 93+?
% drop -16.2% -22.6% -29.5% -37%
% subsequent move 123.9% 75.5% 166% ?

Source: MFM

In the current weak phase of gold, it seems that short-term traders have exploited and exaggerated the price move.
Some commentators have even gone to the extent of blaming co-ordinated bear raids by large financial institutions.
Statistics indicate that the current net commercial short positions, mostly paper contracts on gold futures, are higher than at the bottom of the previous downturn in 2008.
Whatever conditions caused or stimulated the large price drop, in the longer term, fundamentals should prevail and restore equilibrium.
Taking a hard look at our main thesis for higher gold prices, we expected central bank money printing to flood the market with liquidity.
We were also concerned about the financial debt burden in the US, EU and the Japanese systems causing economic weakness, while high unemployment resulted in social unrest and political instability.
Geopolitical events and upheaval in the Middle East add to the uncertainty and risk aversion.
All of the above are still centre-stage among the world’s economic drivers and should be supportive of a higher gold price.
Nevertheless, the reality is that secular trends take a long time to develop and are susceptible to changes in short-term sentiment.
While it is always impossible to call the peak and troughs of any market, there are growing indications that we may be close to a major turning point for gold.
The price decline has been met with a surge in physical demand, in particular from the Chinese.
The US Mint has also recently reported growing sales of gold coins, with volumes surpassing those at the 2011 price peak.
The dramatic fall in gold mining shares is, perhaps, the most difficult to comprehend under the circumstances.
The only fundamental that seems relevant to share valuations at this stage is the long-term price of gold.
All other parameters – such as size of resources, production and profitability, longer term capital expenditure and future projects – appear to have been ignored in the current flight from gold stocks.
Adding to the confusion is the central bank rhetoric which, by default, is designed to introduce optimism.
The US Fed has recently indicated that it may start withdrawing from current liquidity-supportive policies and the ECB appears to have little option but to follow.
The strange thing about this stance is that it appears that the economic growth required for an orderly exit is not expected, even by the Fed.
Could it be that central bankers finally realise that monetary stimulus has yet to produce a meaningful impact on the economy, and the danger of higher inflation, which no one expects at the moment, is rising?
If that is the case, real interest rates could dip further into negative territory, increasing the value of gold.
Confirmation of a turn in the gold price to higher levels is likely to result in a dramatic re-rating of gold mining shares.
Until then, patience is being tested, but those investors who understand the function of gold as a safe haven are likely to hold their positions.