The indifference shown towards gold markets in recent months has been palatable. The asset class has been anything but volatile, and has experienced a deliberate drift lower since the recent peak in early October of last year, falling some 7% over past five months on declining volume. This is despite some notable events that one might have thought would spur more interest in the commodity.
Most interesting among recent developments is perhaps the Bundesbank announcement of German gold repatriation, which many industry participants had speculated upon for some months. Additionally, other central banks, such as those of Russia and Kazakhstan, have been more vocal about increasing gold reserves.
China, the largest gold miner in the world, posted record physical imports in 2012. Several new gold bulls have also emerged, not the least of which is PIMCO founder Bill Gross. Nonetheless, complete apathy reigns.
As recently as a few weeks ago it appeared, at least to the eyes of this author, that precious metals would experience an uptick in volatility. This has not been the case. In fact, excluding JPY denominated gold, the opposite has occurred. So the question is now, what will it take for gold to experience any move of significance in either direction?
Potential Short Term Catalysts
- Technical Breakout
- ETF Inflows/Outflows
- Physical Demand
- Swiss Gold Initiative
This list is by no means meant to be exhaustive. If one looks out over a longer time frame more scenarios come into play such as inflation expectations based on Quantitative Easing (or lack thereof), currency market fluctuations, government policy towards gold imports (India and Vietnam), as well as changes in global macroeconomic expectations.
The trend for the SPR Gold Trust (GLD) has certainly been to the downside over the past 18 months since hitting an all time high of 184.59 in August 2011. Nonetheless, one can hardly say the bears are in control, with GLD having to get below 148 to enter the classical definition of a 20% decline for a bear market. GLD has meandered in a narrow range since hitting its recent peak of 173.61 on October 4th and hitting an interim low of 159.43 on January 7th 2013. Over this period, volume has been very light, with neither buyers nor sellers seeming to have control.
With the ETF now inside 1.5% of its 20, 50, and 200 day moving averages, an abrupt move in either direction is possible on a news item or market action that catches either longs or shorts offside. Elevated price action could be accelerated by the news that broke on Friday that the CME will be reducing margin requirements for gold and silver futures by 10%.
Despite the rotation out of bonds and other asset classes into global equities in recent months, according to SPDR Gold Shares the total amount of gold held by GLD has changed very little since late 2011. The trust's current stockpile is just 1.8% lower than the all time high of 1353 tonnes. The COT report for COMEX gold futures and options also demonstrates the current lack of conviction amongst traders. Overall paper gold markets are in a near state of stasis.
What paper flows of gold do not take into account is the amount of physical gold changing hands. While the math in the electronic world for the yellow metal is rather straight forward to calculate with a basic Excel model, what happens in world bullion markets is altogether another story.
The desire by many in the public to hold bullion as a store of wealth has remained strong. This phenomenon has been notably evident in China, India and Vietnam, despite government intervention to suppress demand in the latter two countries. In India alone, households own an estimated 20,000 tonnes of gold.
The true amount of gold being taken out of circulation is very difficult to gauge. How does one track supply and demand in a market where no firm numbers exist for actual new supply (via mining, with countries such as China not releasing official output), and an asset that is not consumed, but hoarded?
The common, and far from transparent practice of gold leasing, also complicates matters in this regard. For this reason, while physical demand is important in the long run, in the near term, it is unlikely to be a catalyst that would have immediate market impact. An exception to that theory could be large purchases as part of a country's foreign exchange reserve.
Central Bank Buying
The Central Bank Gold Agreements (CBGAs 1-3), which were meant to slowly sell Sovereign gold reserves seem to have come to an end and reversed course, with Central Banks net buyers of bullion over the last two years. Remarkably, 2012 represented the largest sovereign gold purchases since 1964.
Given recent actions by the Bundesbank, Turkey, Russia, and China it appears central bankers will once again be net bullion buyers in 2013. This does not even take into account the likes of Brazil, Mexico, and South Korea, which are all also accumulating gold for official reserves.
Despite the actions of other nations, China has to be the player on everyone's radar at this point as far as sizable accumulation of bullion for currency reserves. The announced size of Chinese gold holding has not changed in many years, and the true tonnage is a mystery to the market, although it is likely that some of the record inflow of bullion into the country in 2012 made its way into official coffers.
One national bank, that of Switzerland, which has thus far had little to say vis-à-vis gold holdings, may find itself uncomfortably in the spotlight if a recent petition circulating in the Alpine country is successful.
Swiss Gold Initiative
The Swiss Gold Initiative was started by four Swiss politicians just under a year ago in order to force the Swiss National Bank to repatriate the country's foreign holdings and stop any further bullion sales. Additionally, the bank would have to hold a minimum of 20% of its reserves in gold within the next five years.
Under Swiss law, if the petition receives 100,000 signatures before the March 2013 deadline, the Swiss parliament must hold a referendum and put the decision in the hands of citizens. With over 90,000 signatures as of the end of January, it appears likely that this story will be generating headlines in the coming weeks. The implications of a change in national banking policy, forced at the hands of voters would have numerous implications for market participants and public officials alike.
Firstly, a national referendum on gold would increase pressure in countries such as the Netherlands where similar movements are entering public consciousness. Secondly, the amount of gold the Swiss would have to buy to meet the legal requirement would represent 130% of the value of outstanding GLD units, or close to double the record amount of physical gold China (the world's largest buyer) imported in 2012.
The outcome of the Swiss Gold Initiative will not be known for some time, but one could see how even a vote on such a proposition would rattle markets. Although unrelated, UBS and Credit Suisse in recent weeks have moved to offer their clients allocated gold storage as another indication that investors are increasingly concerned about the custody of physical holdings. So despite the fact many interesting storylines are developing in global precious metals markets, the paper asset continues like a ship without a captain.
Gold Volatility Remains Cheap
As far as trade setups, the best move may in fact be to be patient. However, for those that are bullish on the sector and would be comfortable adding positions on weakness, selling short dated puts (inside 3 months) and buying longer dated calls would be an efficient setup. The opposite would be true for those bearish on the precious metal. Finally for those who feel the doldrums of the market are just settling in, selling volatility here is an option, but likely not worth the risk reward.
The timing remains uncertain, but one gets the sense that gold must make a break sometime soon after an extended stay in purgatory. With unabated physical demand in many parts of the world putting somewhat of a floor on prices at present, that break may be to the upside. Time will tell, but the catalyst that gold bulls need may well come from Switzerland.