Physical Gold, Miners Surge on Higher Gold Prices. Could This be a Sign of Better Times Ahead?

One day’s trading activity hardly constitutes a trend but the lockstep rise in gold prices and gold mining shares could indicate something more fundamental is afoot. Gold was up 2% on the day and its poorer cousin, silver, did even better, climbing approximately 4%.

The DOW lost 135 points during the Thursday trading session, pointing to an inverse correlation between equities and gold prices at this early stage in the trading year. Few would argue that the rush into general equities has drawn money out of the gold market and in fact contributed to the metal’s worst performance in over 30 years.

The most significant factor impacting gold prices this past year has been the rotation out of Exchange Traded gold Funds (ETFs) into equities. Indeed GLD ETF saw its gold holdings drop by a massive 41% during 2013, indicating perhaps that a bottom for gold is in or is very close to it.

Sales from ETFs have been partially offset by strong physical demand from the East, most notably from China whose appetite for gold seems almost insatiable. Last year, China launched two gold ETFs – with more likely to follow – and these could represent significant new investment gold demand in the future.

Indian consumption, traditionally the highest of any country, has dropped off sharply owing to government taxation on gold imports which is designed to  stem the flow of dollars out of the country. However, that policy has spawned a black market for gold, and contributed to the unpopularity of the current government which will face an election this year. The tax on gold is almost certain to become an election issue and  a proposed repeal of the tax by any party would no doubt garner broad support from the voting public.

Despite the heavy selling from ETFs, investors bought a tremendous amount of gold in 2013 – probably about 29 million ounces which is enormous from a historical perspective. (Nonetheless, it was an estimated 25% lower than the previous year). Asia, Europe and the United States all featured prominently in the purchases. As we begin 2014, all of the problems that precipitated the historic market crash five years ago are still there and in fact many of them are worse.

The Federal Reserve’s recent decision to reduce tapering by $10 billion per month is a two edged sword for the market.  It will serve to boost interest rates and perhaps even tank the housing market which is the main driver in the U.S. economy at the moment. The Fed has warned that interest rates will stay low for many years to come and also that the decision to taper could be revised depending on market conditions. Should this happen, it would be more than apparent to the market that the emperor (or empress if Yellen’s nomination is approved) has no clothes. The impact on the gold market could well be explosive to the upside if that happened.

Whatever action the Fed decides, the unwinding of QE3 could be very messy – not to mention gold positive.  One market  analyst noted after the market close today that the services component in the CPI makes up about 60% of that number which is running at 2.4% yr. on yr. because of higher rents, the highest since 1995.  Rent is a major component in living costs for 35% of the country. Any uptick in commodity prices would compound the services issue and see headline CPI rise appreciably which is bullish for gold.

Today’s action in the gold market lends additional credence to the view that the gold market may have bottomed – although it could take some time for gold to firmly re-establish its multi-year bullish trend.  Gold’s oversold position, coupled with bearish market sentiment that is virtually without precedent, opens up the possibility for a massive short squeeze that could be truly historic in nature. When the pendulum swings too far in one direction, it has a habit of swinging back just as far (or more) in the other direction. We’ll just have to wait and see!

In the meantime, I would invite you to read the following report “Let’s Get Physical” by John Hathaway, Portfolio Manager and Senior Managing Director at Tocqueville Asset Management. Hathaway is arguably the dean of US gold analysts and his analysis could portend what’s in store for the gold market and why smart investors should be positioned in physical gold and gold shares before the inevitable upturn comes about.

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