Odds favour sharp gold price recovery ahead – but when?

Precious metal analyst Jeff Nichols feels the bull market in gold is still intact and has many years to run. Nichols sees the source of gold supply diminishing drastically and the shift from bonds back to bullion will set the stage for a turn-around and recovery in the price of gold.

Author: Lawrence Williams
Posted: Wednesday , 17 Jul 2013

In his most recent analysis of what has been happening in the gold market, New York based long term precious metals analyst, Jeff Nichols, sees the end nigh for institutional selling which he feels has been one of the key contributing factors to the slump in the gold price over the past few months.

While definitely in the pro-gold camp, Nichols has always warned that the bull market in gold, which he feels is still basically intact and has many years yet to run, was always likely to see major corrections. However, the depth of the recent one may have taken him by surprise. Indeed he calls the fall since gold peaked in September 2011 of over 35% as astonishing’.

What his latest commentary suggests is that, in addition to perhaps contributing to moves by other parties to keep the gold price down - in part to cover a likely short supply of gold in central bank holdings due to leased gold - institutional selling has played right into the hands of those who may benefit from lower gold prices.

In the case of the institutions though, the motives are different from those that may be attributed to the bullion and central banks. Quantitative Easing, effectively pumping money into the economy, has seen stock markets rise, even though the impact down the line on jobs and the basic financial situation of most people, has been rather more limited.

However the publicity given in the media to rising markets does generate something of a feelgood factor down the line, which suits the governments of the day. Perception is always heavily in the minds of politicians and there is little doubt there is collusion between the upper echelons of government and those who are charged with managing a nation’s economy, supposedly independent of the state.

Be this as it may, hedge funds and other institutional investors, have been persuaded – and have reaped the benefits – of putting their available funds into the markets where they have seen better short term returns, and those which had substantial gold holdings, perhaps held in the big ETFs, have been offloading them as a consequence.

As Nichols puts it: ”Institutional divestment has been fuelled, all along, by the expectation of higher returns in both equity and debt markets and, more recently, despair over gold’s poor performance with initial selling triggering more selling by momentum followers.”

However Nichols sees this source of gold supply diminishing drastically thus: “..those hedge fund managers wishing to switch from gold to equities and bonds have largely depleted their bullion holdings. In addition, with the recent rise in long-term interest rates, the bull market in bonds is probably over — and, though equities remain strong, some fund managers are wondering just how long the party on Wall Street will last. This shift in expectations is setting the stage for a turn-around and recovery in the price of gold.”

What has happened to all this additional gold coming on to the market? Well it mostly seems to have been snapped up by buyers, particularly in the East, and notably in China, but also elsewhere in the world – particularly in those countries, like Argentina, where inflation is rife and gold is seen as an alternative currency with staying power.

Indeed Max Keiser, in yesterday’s Keiser Report, commented he’d picked up on some newswire an unconfirmed report that Argentinian gold price premiums were so high that purchasers were having to pay over $1900 an ounce for the yellow metal! That represents around a 50% premium. While this is obviously not the norm – even in China premiums are running mostly in single figure dollars per ounce – it does indicate that there remains this tremendous underlying demand for gold – and, unlike in the U.S. where most gold is traded to make a turn on the price, elsewhere it is largely flowing into firm, safe hands.

Because of the lower gold prices now prevailing, which make many operating gold mines and projects uneconomic, we are already seeing a fallout among producers with cutbacks, shutdowns and postponements. As a result global gold production is likely to decline until there is a major pickup in the metal price. The lower price also discourages scrap sales which have thus been diminishing too. Meanwhile the huge demand for physical gold seems to be continuing apace.

Now, if Nichols is correct in his analysis that the institutional sellers of gold are beginning to review their sales policy – or indeed may have no more gold left to sell – and if the rumours that central banks and the bullion banks are short of bullion too, then we could see a sharp squeeze developing as those looking to buy physical gold are finding it is just not available. Banks will start – indeed some have already started – telling customers who want to take delivery of their supposedly allocated physical gold, that they can only have cash instead.

This is in many ways indicative of the Central Banks’ money printing initiatives. Effectively printing more and more unbacked cash to meet obligations is the classic Faustian route to economic disaster. Some day, if confidence starts to be lost in the central banks – one just doesn’t know how soon – this will all come crashing down in default and/or inflation – or even in hyper-inflation.

But this could all be a long way down the road. It just depends on how long the public can be convinced that the governments are fully in control and all is well. (Eurozone nations may already be past that point!) In the meantime though, as Nichols ends his analysis: “Only now, having sold gold in the past couple of years, Western institutions may find it difficult to rebuild their gold ETF holdings without bidding gold prices to much higher levels because many of the buyers since 2011 — Chinese households or the Russian central bank, for example — have no interest whatsoever in selling . . . not now and not for many years or even decades to come.”

He may be right. Gold can’t continue to fall in price without driving a considerable portion of the gold mining sector out of business, decimating new supply. It could also be the case that China might step in to protect the value of its citizens’ gold holdings which are now substantial. As Grant Williams noted in his latest analysis which we have also just covered here on Mineweb, there are many ‘Unknown, unknowns’ out there affecting the gold market which could move it one way or the other, but in our view the odds seem increasingly that we are heading towards a sharp gold price recovery – the only real question is when?

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