The week ahead is shaping up to be an important test for precious metals markets that have struggled recently in the wake of a sharp sell-off on November 28th as detailed here a week ago.
On Tuesday and Wednesday this week, Federal Reserve officials gather in Washington for a policy meeting that is expected to conclude with an announcement that the central bank will increase its monthly money printing effort from $40 billion to $85 billion. Since gold and silver have disappointed investors since QE3 (the Fed's third round of "quantitative easing") was launched back in September, their reaction to this week's Fed meeting should determine whether the metals end the year with a bang or a whimper.
Some hedge funds and investment banks seem to be losing interest in this sector as prices have fallen in recent weeks (and it's important to remember that big leveraged funds operating in futures markets set the prices for gold and silver), however, as has been the case many times over the last few years, lower prices have prompted strong physical demand by emerging market central banks and retail investors around the world. This should provide strong price support regardless of how the metals react to what the Fed has to say on Wednesday.
For the week, the gold price fell 0.6 percent, from $1,715.20 an ounce to $1,704.50, and silver dropped 1.0 percent, from $33.44 an ounce to $33.11. Gold is now up 8.8 percent in 2012, down 11.4 percent from its high last year, and silver is 18.8 percent higher this year, down 33.1 percent from its early-2011 high.
To be sure, it has been a disappointing stretch for many gold and silver investors since Fed Chief Ben Bernanke announced QE3 in September. Since new rounds of money printing have been one of the key drivers for higher precious metal prices in recent years (along with low real interest rates), the failure to mount sustained price advances over the last three months has some analysts questioning whether the gold bull market has come to an end. That's exactly what investment bank Goldman Sachs forecast last week, however, upon closer inspection as detailed here on Thursday, they don't seem to have much of a case.
Perhaps the real problem here is that too many traders and investors haven't really followed gold and silver prices long enough to realize that what we've seen over the last year or so is a fairly typical correction that has yet to run its course.
As shown below, after dipping above and below the corrections that began in 2006 and 2008, the gold price is now about even with those two and anyone thinking that the relatively modest setback that began in 2009 should be used as a guide is understandably disappointed.
They shouldn't be.
Major gold price correction normally last about 18 months, but the good news is that those 18 months are just about up.
Of course, hedge funds are not known for being terribly patient and this explains a lot of the volatility that has been seen lately as algorithmic-selling has resulted in the liquidation of many futures positions after the gold price failed to retake the $1,800 an ounce level last month.
When this sort of momentum fails, futures traders tend to just look at each other and soon find themselves looking at each other scrambling for the exits, selling first and asking questions later. After reaching a 14-month high on November 23rd, open interest in gold - a key gauge of market sentiment - has dropped 10 percent (in no small part due to the sharp sell-off on Wednesday the 28th) as the price dipped below its 100-day moving average to a one-month low last Wednesday.
But, the recent pullback has sparked a new round of physical demand for both gold and silver and this should underpin the market.
That was clearly the case last week when gold dipped below the psychologically important $1,700 an ounce level and physical buying ramped up.
Indian gold demand rose sharply as the world's most price-sensitive buyers snapped up the metal at lower prices last week. After gold imports tumbled earlier in the year due to rising duties and other efforts by the Indian government aimed at curbing gold buying, demand has surged in recent months as it was recently reported that Indians purchased over $7 billion in jewelry in the third quarter. Strong wedding demand is expected to continue well into the new year.
In China, demand has been steady, though imports from Hong Kong fell more than 30 percent in October to 47 tonnes, the lowest since February. Net gold flow from Hong Kong to China at 400 tonnes has already surpassed last year's total and one of the big questions to be answered early next year is whether China will surpass India as the world's largest source of gold demand. Gold buying has recently fallen off, but is expected to improve in the last two months of the year as dealers stock up for year-end festivals and the important Lunar New Year in February.
South Korea's central bank said last week that it increased its gold reserves in November for the fourth time since the bank bought gold in July of 2011 for the first time in 13 years. The 14 tonne addition brings their holdings to 84 tonnes, or just one percent of their foreign exchange reserves, meaning that there will likely be more gold buying ahead. This is just the latest example of Asian central banks swapping out Western paper assets for something more tangible and, according to the World Gold Council, global central bank gold buying is expected to reach a new high this year at over 500 tonnes, up from 457 tonnes in 2011.
Here in the U.S., gold coin sales rebounded to record their strongest November in 14 years as bullion dealers reported an influx of high net worth individuals who said they prefer to take possession of the metals rather than purchase ETFs or similar bullion funds.
As shown below, gold dealer BullionVault reported that gold buying reached a six-month high of over a half-tonne of the metal in November.
While this is down substantially from the level of a year ago, it is consistent with other measures of strong physical demand amid ongoing price weakness.
Holdings of the world's largest gold-backed exchange-traded funds reached a new record as the SPRDR Gold Shares ETF (NYSEARCA:GLD) added almost five tonnes.
The iShares Silver Trust ETF (NYSEARCA:SLV) added 71 tonnes to its holdings last week after steady outflows during most of November, perhaps signaling a change in sentiment.
It's been a difficult 15 months for gold investors and an even longer wait for silver investors awaiting a rebound in the metal prices sufficient to recapture their respective 2011 highs, however, they may not have to wait much longer.
This week's Federal Reserve meeting could be the catalyst for a sustained rise in precious metals prices, however, that is by no means guaranteed. In a research note last week, Nomura said they expect the gold price to rise in advance of the Fed announcement on Wednesday and UBS analysts said that more Fed money printing is not currently priced into the gold market, meaning that the Fed's next policy move could prompt a "sizable response."
Disclosure: I am long GLD, SLV. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: I also own gold and silver coins and bars