Gold as an investment vehicle has been written off by most market pundits after its sharp fall over the last one month. But after that fall, it now trades at a 10-day high. While the pundits may argue that it is a dead cat bounce, and the shining metal will fall again, there is an underlying bull case to this rally, which has the potential to take gold to a new high.
In the first place, there is no clarity yet on why gold fell, especially after Cyprus and Portugal denied selling their reserves. Some are blaming it on program trading, while others are ascribing it to misinformation being spread by interested party. The only plausible explanation seems to be ETF redemptions. Whatever the case may be, according to details available now, the fall resulted in a worldwide shortage of the precious metal as buyers rushed in to capitalise on lower prices. Further, the metal seems to have moved into stronger hands now.
Central banks had bought the most gold since 1964, just before prices tanked. Countries ranging from Colombia to South Africa have all added gold to the tune of 534.6 tonne, the highest in nearly half a century. Russia and Kazakhstan added gold for the sixth straight month says a report from IMF. Central banks now own 31,671 tonne of gold, equivalent to nearly 19& of gold ever mined. These banks are expected to add another 450-550 tonne in the current year, which is nearly a fourth of the annual supply.
Buying by long-term holders had, earlier, created a temporary shortfall in the market. Gold prices posted the highest weekly gain on strong physical buying across Asia. Dubai, the 'City of Gold' had buyers lining up outside stores for the metal resulting in a temporary shortfall. Gold, after many years, was being sold at a premium not only in Dubai but also in Europe. The premium of gold bars in Singapore is at its highest since October 2008 on demand from Indonesia, Thailand and India. The Chinese Gold & Silver Exchange Society is rush-ordering four times its usual amount of gold bars from Switzerland and London to meet the increased demand.
Sales of gold coins by the US Mint are expected to touch an all-time high with sales in April (till Wednesday) touching 196,500 ounces, up from 62,000 ounces in March 2013. Its previous high was in December 2009 at 231,500 ounces.
In India, gold importing banks have run out of stocks and are facing supply shortfall. Reports say, refiners are sold out till second or third week of May and the country may continue to face a shortfall.
There is little justification in the world economy for a bear market case for gold. The reasons that led to a steady rise in gold prices are even stronger now than they were at the start of the rally. Central banks continue to print more money, European debt crisis is spreading, and recent set of data shows the US is unable to enter a secular growth phase. Investors' trust on the dollar isn't too strong, while money is not flowing in other commodities as their price rise is not sustainable given the direct impact on growth.
Recent events have highlighted that there is genuine demand for physical gold in case price moves lower. However, the biggest bull case for gold is the rising short position in the commodity. CLSA's Greed and Fear report by Christopher Wood says: The gross short position on Comex gold has increased from 7.4 million ounces at the end of 2012 to 11.7 million ounces on April 9. It touched a high of 13.1 million ounces in mid-February, the highest since July 1999.
Gold is considered to be a hedge against monetary and political instability, and if this is a yardstick we have still a long way to go before the end of the crisis is in sight. As Wood says in his report, "… gold is not a 'commodity' but money. Indeed gold is the purest form of 'money' available not contaminated by the current fiat paper system, a system increasingly, corrupted by manipulation of the high priests of paper money, otherwise known as central bankers."
Japan and the US have embarked on a record quantitative easing policy; there are very few asset classes in the world that can absorb this spurge in liquidity, gold is one of them. The case rests.