By Jeffrey Nichols
The snap-back in the U.S. dollar price of Gold this past week to $1,100 an ounce may mark the beginning of a new upward phase in the metal’s long-term bull market. Importantly, gold found support near its early February 14-week low point of $1,045 after a two-month-long retreat. But until gold breaks above its December U.S. dollar-denominated all-time high of $1,227 many players in U.S. markets will remain skeptical of the bull market’s staying power.

A break above that level could touch off another speculative buying surge and drive the price much higher. But, meanwhile, developments elsewhere promise to move gold higher – from recent levels, first to $1,150, then $1,200 and eventually to new heights.

Americans look at gold prices from a U.S. dollar perspective. So it went largely unnoticed by many in this country that the yellow metal’s price in euros, Europe’s single currency, touched a record level in recent days. Chartists across the Atlantic will make note of this development – and speculators jumping ship from euro-denominated debt may begin to see gold in a more positive light.

In fact, it is noteworthy, that as the greenback rose against the euro in recent days, gold’s dollar price still managed a healthy recovery. Perhaps this is the signal we’ve been expecting, the signal that gold can – and will – move higher even as the dollar is also advancing against the major Western industrial world currencies.

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Even more importantly, much of the recent buying interest is emanating from Eastern markets – particularly India, China, and other Asian nations that are enjoying early recoveries in economic growth and personal incomes. Moreover, in these markets we are seeing buying mostly of physical gold – the real thing – and many of the buyers are unlikely to sell their metal back anytime soon, if ever!

In contrast, much of the selling over the past couple of months has been of paper gold – particularly futures and options –by traders and speculators in Western markets taking short-term positions without much regard for the yellow metal’s intrinsic value or positive fundamentals.

This process is transferring ownership from weak hands to strong, from traders and speculators who think in hours and days, to long-term accumulators who think in years and decades . . . and for whom gold is traditional form of savings and wealth preservation.

Over the long-term, Asian gold demand will depend on sustainable growth in business activity, employment, and personal incomes. Hence, steps taken by the People’s Bank of China or the Reserve Bank of India – recently and in the future – to prevent economic overheating and a resurgence of high inflation are healthy developments for gold.

Some small share of rising household income in these emerging economies will find its way into Gold (whether bars, coins, or investment-grade jewelry), given traditionally high savings rates and a tradition of holding some savings in the form of gold in many of Asia’s strongest economies. And, at the same time, rising personal incomes and wealth will boost demand for gold jewelry.

The best scenario for gold would be strengthening, but not overheated, economies with inflation remaining at acceptable rates. A spike in inflation in these counties – particularly China – would more likely be met by monetary tightening, higher interest rates, slower economic growth, less savings and investment in gold, and reduced demand for gold jewelry.

Another likely area of support for gold could well be central bank gold purchases from the East Asian high-growth economies. Last year, India and China led the list of official gold buyers. India purchased 200 tons (at an average price of $1,045) directly from the International Monetary Fund while China purchased significant – but unreported – quantities from its domestic mine output.

We’ve opined in recent weekly reports that China could be the next big buyer from the IMF, particularly if prices dipped below those paid by India for its purchases last year. One could well imagine that recent off-market purchases by the People’s Bank of China (PBOC) directly from the IMF may have occurred as soon as the market price dipped to the $1,045 per ounce paid by India.
News came last week that China’s largest sovereign wealth fund, the China Investment Corporation (CIC), recently purchased 145,000 ounces (about 4.5 tons) of gold in the form of gold ETFs. While not the central bank (and not a significant quantity given the country’s huge foreign exchange reserves), it is likely that this investment was approved by the central bank and may, indeed represent a “stealth” purchase on behalf of the PBOC.

In any event, I view this as a very bullish, but largely unnoticed and little discussed, development for gold, signaling both China’s interest in acquiring more of the yellow metal, and its “official” point of view on future gold price trends.

News that China is buying – whether directly by the PBOC or more by the CIC as the central bank’s proxy – could very well touch off a wave of official purchases by other reserve-rich central banks (or their own sovereign wealth funds) wishing to diversify their reserve holdings and reduce their U.S. dollar exposure. (Jeff Nichols is Senior Economic Advisor to Rosland Capital)

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