MoneyWeek magazine’s house view on gold is that you should hold it as insurance – five to 10% in your portfolio.
This is to offer you some protection from the eventual inflation that central bankers are keen to unleash on the world.
But what if – like me – you’re rather more exposed to gold than that?
This morning I want to take a look at what’s next for the yellow metal.
Like it or not, the trend for gold is down
When it comes to gold, the technicals and the fundamentals are shouting very different messages.
We’ll start with the technicals – the study of the price. When all is said and done, you can’t argue with the price.
The chart below shows gold since 2006. I have identified the broader trend – the general direction – using blue tramlines. In simple terms, what was heading up, is now heading down.
Long-time readers might remember how I used the 144-day simple moving average (144-DMA) to catch the lows in gold as it moved up between 2008 and 2011. This proved a useful tool.
But it is now working in reverse. As gold trends lower, the 144-DMA is now catching the highs. In the chart below, the gold price is in black, and the 144-DMA is in red. Gold’s recent rally above $1,400 an ounce stalled right on it.
Gold is currently enjoying a mini-surge. The implication of the above chart is that said surge will fizzle out when gold reaches that 144-DMA, currently at $1,367 and falling.
Nobody wants the gold price to rally more than I do. But I cannot argue with the trend. And, for the moment, that trend is down.
Trends can last for many years. They can defy logic, reason and fundamentals. But they do not go on forever.
Perhaps the June lows of $1,180 marked the bottom. I hope so. It’s possible a new trend is forming now.
But until gold can get above the 144-DMA, and said moving average turns up, and until gold can break above the range identified by the falling blue tram lines in the first chart, it will remain, by my analysis, in a downtrend.
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The fundamentals behind gold are solid – and it’s not just money-printing
Now, let’s look at the fundamentals. We’ll leave aside the terrifying amounts of money and debt created by Western central banks over the last two years. They may well come to have an effect on the gold price – perhaps if there’s some kind of currency crisis – but for now they haven’t.
Instead, I want to look at another big driver of the gold price – Asian demand. There are a lot of people in southeast Asia, and that’s where the gold demand is coming from.
In the first half of 2013, gold holdings (mostly Western) in exchange-traded funds (ETFs), mutual funds, and repositories fell by about 26 million ounces (about 800 tonnes). Where did all the gold go?
Well, in that same period, around 800 tonnes of gold was exported from London to Swiss refineries, where it was converted from 99.5% purity 400oz London good delivery bars, into 99.9% purity kilo bars – Asian size and quality.
In short, the gold went to Asia.
And not only has it gone from west to east, it has gone from weak hands (it is easy to sell Comex or ETF gold – in some cases you don’t even need to own it to sell it) to strong hands (holders of actual physical gold, particularly in Asia, don’t sell easily. Many don’t even have access to banks).
Even with its government’s efforts to stop people buying gold, Indian gold demand stands at around 1,000 tonnes per annum (excluding smuggled gold, which is on the rise).
Meanwhile, there is Chinese gold demand. Goldmoney’s Alasdair McLeod writes: ‘The Shanghai Gold Exchange is the mainland monopoly for physical delivery, and Hong Kong acts as a separate interacting hub. Between them in the first eight months of 2013 they have delivered 1,730 tonnes into private hands, or an annualised rate of 2,600 tonnes”.
World gold production in 2012 was about 2,800 tonnes, barely enough to cover Chinese demand. But that number will fall in 2013, as many mines have been shut down. I estimate it will be around 2,400 tonnes.
Where will the gold come from?
So, where is the gold going to come from to meet rising Asian demand?
Some will come from China itself. China is already the world’s largest producer. Its share of production will rise from around 404 tonnes in 2012 to 440 tonnes in 2013. But China keeps all the gold it produces. I’ve had long conversations with the gold auditors in the vaults at HSBC. They hardly ever see Chinese bars.
But the rest? Not from new mine supply. Mine supply is falling. Most mining companies, for all they may tell you, cannot make money at current prices. As Hinde Capital’s Mark Mahaffey argues so eloquently on his blog, “it costs over $1,750 to mine an ounce of gold if you add in all the costs of running a mining company, not the published cash costs or the all in sustaining costs.” Gold mining is not a viable business at $1,300 gold.
In the past, shortfalls in gold supply have been met by central bank sales. However, central banks are now net buyers.
How much more can come from Western sales, which covered a large chunk of this year’s shortfalls? There are only about another 2,300 tonnes left in Western repositories, ETFs and mutual funds. And I suspect that those who were planning to sell have already sold.
That leaves scrap. And it alone won’t meet the shortfalls in global demand. Scrap supply may even be falling: you may have noticed that, with lower prices, the once raging ‘cash for gold’ game has all but died a death.
So despite the ugly technicals mentioned above, this shortfall in supply points to higher prices ahead.
And at present I understand that one of the most popular (or crowded) commodities trades is ‘short gold’. Crowded trades often end with a lot of people running for the exit (ie, buying gold) at the same time.
The trend in gold is down. And I don’t know when it’s going to turn. But I would not be a seller here.
(If you want to check up on how some of my other recent trading ideas have fared, have a look here: Four trading ideas: An update.)
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