Bernanke is only partly right about gold

Fed Chairman Ben Bernanke stated that no one, including himself, understands gold prices. Its more like: gold is difficult to understand and it takes a lot of work to analyze the factors and their influences on the precious metal. Gold is influenced by many things including everything from central-bank talk to moves in the U.S. dollar.

By Myra P. Saefong
July 19, 2013, 6:01 a.m. EDT
Market Watch

SAN FRANCISCO (MarketWatch) — Federal Reserve Chairman Ben Bernanke said no one, including himself, understands gold prices, but that doesn’t mean you can’t.

“Nobody really understands gold prices and I don’t pretend to understand them either,” Bernanke said during the Senate Banking Committee hearing on Thursday.

He’s not too far off the mark. It’s more like: gold is difficult to understand and it takes a lot of work to analyze the factors and their influences on the precious metal.

After all, gold GCQ3 +0.69% is influenced by many factors every day. Those include everything from central-bank talk and technical price triggers to exchange-traded fund flows, moves in the U.S. dollar, physical demand and the outlook for the global economy.

“Gold is the asset everyone turns to when the world is going to hell in a handbag,” said Jonathan Citrin, founder and executive chairman at investment firm CitrinGroup.

And to predict the metal’s future value, “one must be able to predict demand, the impact of global monetary stimulus, relative currency values, inflation’s probability, equity-market trajectory and more,” he said. “It is near impossible to predict any asset’s future, with gold being atop the list of the most difficult.”

But gold’s moves often do make sense. So if investors look more closely at what’s been happening to the yellow metal, especially when it comes to basic supply and demand issues, they will get a good idea of what direction it may favor next.

The Fed

Let’s start with the uncertainty surrounding the Fed’s $85 billion a month in bond purchases, also known as quantitative easing.

QE tends to weaken the dollar and raises the risk for inflation. Gold often benefits from a weaker dollar and is seen as a hedge against inflation, so at its core, gold’s reaction to QE and the potential tapering of it is tied to the outlook for the metal’s demand.

The first round of QE began in late 2008 and gold prices shot up almost in a straight line to their all-time high near $1,900 an ounce in August 2011. Recently though, they’ve hit their lowest levels since 2010, as the market expects the Fed to ease back its QE program in the wake of an improving U.S. economy.

“The assumption here is that the economy isn’t too fragile to survive the crutch of QE being pulled away,” said Brien Lundin, editor of Gold Newsletter. “There is some doubt on this, even within the Fed.”

Bernanke said on Wednesday that the proposed timetable for tapering bond-purchases was not set in stone and on Thursday, he said it was too early to make a judgement on whether the central bank will slow down asset purchases at its September meeting.

“The Fed is currently running a merry dance of keeping everyone guessing,” said Jan Skoyles, head of research at The Real Asset Co., a precious-metals investment platform provider. “One week they say they want to taper, then Bernanke says he’ll carry on printing for the foreseeable future and then [Wednesday] he couldn’t make up his mind.”

It’s no wonder gold is so volatile.

Specifically, Bernanke said Wednesday that “because our asset purchases depend on economic and financial developments, they are by no means on a preset course.”

In other words, just because Bernanke said “tapering was on his mind last time around, it doesn’t mean that he’ll necessarily do it,” said Adam Koos, president of Libertas Wealth Management Group.

Still, investors and traders alike are “big fans of potential delays in the tapering of QE,” he said. The “same goes for interest rates and tightening of the Fed balance sheet,” but it’s going to “take more of the latter to see a material long-term change in the gold trend.” Read about why heavy shorting of gold may lead to a rally.

Supply and demand

Gold investors have been so preoccupied with the Fed lately that they might be missing out on some other important factors in play for the gold market.

Demand from Asia, for one, is often mentioned among analysts notes as a key reason for a climb in gold prices on any given day.

“Focus on gold-price volatility has distracted most U.S. investors from noticing the strong demand for physical gold, especially by Asian investors,” said Edmund Moy, chief strategist at gold-backed IRA provider Morgan Gold.

Lower gold prices spurred the strong demand in Asia, resulting in a huge transfer of physical gold from the U.S. to Asian economies, especially China, he said.

Comex warehouse gold stocks have been falling sharply. Among companies that store gold in Comex’s warehouses, Brink’s Inc. recently has seen a massive decline in its gold inventories, falling to 257,000 ounces on July 11 from 570,000 ounces on July 3, according to Mark O’Byrne, Dublin-based executive director at GoldCore — that’s a one-week drop of 55%.

A fall in gold held in trust by the SPDR Gold Trust GLD +0.81% has also been a key reason for gold’s price decline this year, with prices down more than 20% for the year so far. The ETF’s gold held in trust stood at about 936 metric tons Wednesday, down from roughly 1,350 metric tons on Jan. 2.

“Comex and GLD inventories are declining. That physical [gold] is going somewhere,” said Skoyles. “If it wasn’t in demand, then it wouldn’t be leaving the warehouse.”

She points out that net gold exports to China continue to climb on a monthly basis, gold coin premiums “remain on the up” and there are huge premiums on the Shanghai Gold Exchange as well as record deliveries.

The Shanghai Gold Exchange supplied 1,098 metric tons in the six months through June, compared with 1,139 metric tons for all of last year, according to Bloomberg, citing data from the bourse.

“This is a very large number and the market has yet to appreciate the scale of Chinese demand,” said O’Byrne. Demand from India, as well, “is set to remain robust for the entire year despite the recent sharp fall from record levels.”

That robust demand comes at time when mining companies, including AngloGold Ashanti Ltd. AU +2.91% ZA:ANG -2.52% the world’s third largest gold producer, are announcing cuts to production following the 23% price drop in the second quarter.

Several companies have announced they are not going to develop a mine or expand their mines because of where prices are right now, said Malcolm Gissen, co-manager of the Encompass Fund ENCPX -0.71% . Eldorado Gold Corp. CA:ELD +2.43% EGO +2.52% is among the more recent.

Supply has grown only about 2% per year for the last 40 years, according to Gissen. “If we see supplies decline in the next six months, we could see consumers, especially in Asia, step up buying.”

And that’s a force to be reckoned with.

Buyers in Asia and the Middle East are “strong hands” who will hold onto their metal as a store of wealth, O’Byrne said. “Their significant, and still very robust, demand should support prices between $1,000 an ounce and $1,200 an ounce.”

That’ll “likely lead to a resumption of gold’s bull market before the end of the summer and into 2014,” he said.

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