LAUNCESTON, Australia: Until Cyprus’s banking woes hit the headlines last week it had all been downhill for gold this year, with investors selling amid a slew of analyst downgrades.
The question is whether the Cyprus situation is just a temporary blip in an otherwise bearish story, or whether the 3.6 percent rally in spot gold since the Feb. 21 year low is the start of something more sustained.
The recent downgrading of gold price forecasts by several leading banks would suggest that the market has grown weary of waiting for gold to resume its decade-long rally and finally crack the $2,000-an-ounce mark.
The bearish view is supported by the recent drop in net-long positions, as reported by the Commodities Futures Trading Commission, to the lowest level in six years, as well as the 7.3 percent drop so far this year in exchange-traded fund holdings.
Furthermore, the fear that monetary easing in the US, Europe and Japan will eventually stoke rampant inflation has so far remained just that — a fear, so far unrealized and with little short- to medium-term prospect of materialising.
But to my mind the most convincing bearish argument has been slower physical demand, particularly from top consumers India and China.
I have long argued that for gold to resume its rally, which peaked at just over $ 1,925 an ounce in September 2011, it will take renewed buying from China and India.
And it is here that the gold bulls may just be able to take some comfort, as there are signs that demand in both nations, which together account for about 40 percent of the physical market, may be increasing.
India’s gold imports surged 23 percent in January from a year earlier, reaching an 18-month high of 100 tons.
While this was inflated by a rush to buy ahead of an increase in gold import taxes, but anecdotal evidence from traders in India suggests that the new impost didn’t curb purchases as much as feared.
The obvious risk to Indian gold demand is that the authorities take further, and more decisive, steps to limit imports in an effort to lower the current account deficit.
But the lack of new measures in the budget presented last month and a tacit acknowledgement that the government has limited scope to prevent gold imports suggest that Indian demand may well recover in 2013, after declining 12 percent last year.
Turning to China and here the picture is somewhat more mixed, with anecdotal reports of stronger demand contrasting with a slump in gold exports from Hong Kong to China, the main way the precious metal enters the Middle Kingdom.
The net flow from Hong Kong to China fell to a three-month low in January despite buying ahead of the Lunar New Year holiday in early February.
It may take a few months yet to see if China’s gold demand is likely to increase in 2013 after being flat in 2012.
But if India’s demand can recover strongly and China’s growth is even only moderately higher, this should be enough to offset lower demand from ETFs.
This of course assumes that net redemptions from ETFs don’t increase much from the 157 tons sold so far this year, and perhaps the recent gain in the price to around $ 1,615 an ounce will convince investors to keep their bullion holdings.
A further, contrarian indicator for gold is that the cutting of long positions by funds has in the past led to a price rally.
Net-long positions dropped to 39,631 by March 9, the lowest since March 2007, before recovering slightly last week to 43,195.
When net longs dropped in July last year, gold went from around $ 1,600 an ounce to almost $ 1,800 by October.
It seems that gold does indeed have some room to stage a rally, but there’s no convincing evidence that it will be a sustained move higher.
One message that was apparent from attending the Mines and Money conference in Hong Kong this week is that the investment community has grown tired of waiting for gold to resume its upward trend.
In a conference full of gold miners and gold bugs, it was hard to find voices that thought the precious metal was down for the count.
But even they acknowledged that trying to sell private equity and other investors on gold projects has become incredibly difficult.
A resumption of demand growth in China and India may just be the catalyst for gold to rally, but the evidence for this just isn’t in yet.
For now, a rally built on Cyprus will remain decidedly shaky.
— Clyde Russell is a Reuters market analyst. The views expressed are his own.
