(Posted: February 21, 2012)
With the Greek drama taking an intermission and the euro strengthening at the U.S. dollarâ€™s expense, it looks like gold wants to move higher â€“ and, quite possibly, it has enough oomph to break through strong technical overhead resistance as we approach and possibly exceed $1,800 an ounce.
As I have pointed out in past NicholsOnGold commentaries, it is important to distinguish the forces and players that drive gold prices in the short term â€“ measured in days, weeks, and sometimes months â€“ from those that determine the longer-term trend and average price over many years.
In the short term, the dominant players are institutional traders and speculators â€“ the trading desks at banks, hedge funds, and other financial firms â€“ who operate principally in â€śleveragedâ€ť futures and derivative markets.
With little cash down, these are the folks who are most responsible for goldâ€™s sometimes-extreme price volatility, often with big ups and downs from moment to moment, day to day, and week to week. Rather than allowing long-term forces to push gold prices up at a more measured rate, these traders were responsible for driving gold sharply higher last summer to its all-time high near $1,924 on September 6th . . . and then reversing gear and driving the yellow metal back down to $1,525 or thereabouts.
What motivates these traders is the necessity to make short-term trading profits. This is what theyâ€™re paid (and often generously rewarded) to do! They have no lasting long-term interest or allegiance to gold as an inflation hedge, portfolio diversifier, or insurance policy against economic and political risk.
One moment they can be trading currencies, Treasury securities or index futures, the next gold or grains. Their decisions to buy and sell are often based on technical indicators, computer program trading models, or their interpretation of the latest economic indicators or geopolitical news.
While their collective trading volume and the size of their individual trades may, at times, be huge enough to move the price by more than a few dollars, they rarely operate in the actual physical market where bullion bars are actually bought and sold.
What does affect the physical market â€“ the supply and demand for actual bullion bars â€“ are the long-term factors that together set the average price over the years and decades. Here, the key players are:
- Retail and institutional investors who hold gold for protection against currency depreciation and debasement, domestic price inflation, and an assortment of political, economic, and financial risks.
- Central banks who hold gold as an official reserve asset whose value, unlike foreign currency reserves, is independent of sovereign issuer risk.
- Jewelry consumers, who buy for some emotional â€śfeel goodâ€ť needs and desires . . . or as a convenient and traditional form of gold investment (in countries like India and China). These buyers may become suppliers of gold to the physical market, taking profits when prices are perceived to be excessively high or when personal economic fortunes are bleak.
- And, mining companies who regularly add new supply to the market â€“ but with total quantities changing little from year to year.
It is in this physical realm that the long-term average price is set collectively by the buyers and sellers of actual metal.
And, it is our expectations of future supply/demand trends for physical metal that support our long-term forecast of much higher gold prices in the years ahead.
It also explains why our long-term views depend little on the latest swing, however extreme, in the yellow metalâ€™s price.
Bullish Macro Trends
That said, prospective world economic and political developments look likely to affect both the short-term and long-term players in a like fashion â€“ with both groups contributing to an imminent rise in the gold price:
- Most significantly, further monetary easing by the world’s three top central banks â€“ the U.S. Federal Reserve (the Fed), the European Central Bank (the ECB), and the People’s Bank of China (the PBOC) â€“ is likely as the great global recession continues to worsen. As in the past, quantitative easing and other stimulative monetary policies will trigger both short-term and long-term buying as traders seek to make a quick buck and investors seek protection from the expected inflation consequences of record high monetary creation.
- Irrespective of short-term cyclical weakness in both China and India, I expect long-term demand from investors and jewelry buyers in these two countries will continue to boost gold prices quite significantly â€“ not just in the next year or two, but for many years to come â€“ reflecting the rising incomes and growing middle classes in these two countries.
- Central bank interest will not only continue but will likely expand in 2012 â€“ with China and Russia leading the pack. Moreover, I expect a growing number of countries underweighted in gold and over weighted dollars and euros joining in this official-sector gold rush. Â Periodic news of one central bank or another accumulating gold will also trigger bouts of speculative demand.
Finally, there are a number of â€świld cardsâ€ť that may affect gold prices â€“ for better or worse â€“ in the weeks and months ahead. At the top of my list:
- Americaâ€™s political log-jam and Washingtonâ€™s inability to reach a consensus on important federal debt and budget measures.
- Heightened tensions in the Middle East â€“ with saber-rattling by Iran, oil-price uncertainties, approaching Egyptian elections, and the threat of civil war in Syria.
- Europeâ€™s continuing sovereign-debt crisis, further downgrades by the credit-rating agencies, the still-possible Greek default and departure from the euro-zone, possibly followed by other deeply indebted European countries.
- And, perhaps most importantly, how the U.S. dollar reacts in world currency markets to any of these unfolding developments.