Gold: New York Passé, China The Price-Setter

by: Patrick MontesDeOca

In a recent interview, London gold and silver whistleblower Andrew Maguire said that the current precious metals markets are going through a historic transition as market prices shift from being set by paper exchanges in London and New York to prices being set by the physical price of gold in India and, with increasing influence, in China.

"In 30 years of watching the gold and silver markets," Maguire said, "I haven't seen anything this exciting."

Echoing what I have argued and what Maguire has said on recent interviews, the constant selling of gold and silver on the paper markets defies the fundamentals in relation to the increasing demand for physical gold.

While bullion banks and hedge funds in the West play the gold and silver paper markets, selling short while spreading news of a bear market, the demand for physical gold in India and China skyrockets as Asians take advantage of the discount in physical prices caused by the short selling on the paper markets. Since the price of gold is set by the paper markets, the price of physical gold offers a significant discount to what the price of physical gold should be on the physical market. In the near future the paper markets will no longer set the price of gold. The price of gold will be set by the supply-demand balance of physical gold.

Maguire believes, as I do, that "China is going to become the global marketplace for precious metals… Not New York or London. The physical demand is not there; it's in China and the emerging markets."

With its leadership eyeing the near future, China is buying gold to back the Yuan to create the foundation for the Yuan to supplant the US dollar as the world's reserve currency. This process, Maguire argues and I fully agree, is being done as secretly as possible, but there is ample evidence as shown by the massive increase in gold purchases in China. For decades India was the largest purchaser of physical gold. China now buys more gold than India and the Indians are forced to compete for gold on the global market, mostly against the Chinese. Maguire argues that sooner than he ever thought possible, China gold market will set the world price and the Yuan will become the world's reserve currency.

Recently I asked Mr. Rule (Global Companies) about where he thought the value of the US dollar was heading. In the near term, he said, "I think the dollar's going to be strong…I've jokingly said, it's the worst currency in the world, except for all of the others." He stressed that the US dollar is still the world's reserve currency and it is the most liquid currency, which, in the short term, should help it retain its value against other currencies.

In the longer term, with the Japanese taking down the yen, which makes their exports cheaper, a ripple effect will develop. As Japanese exports become cheaper, other East Asian exporters, such as Taiwan, Korea, and Malaysia, and maybe even China, will have to answer the devaluation or face competitive pressures in their export markets. The ripple, however, will not stop in Asia. Europeans then will have to weaken the Euro or become uncompetitive. At that point, the United States will have to devalue, let the market devalue the dollar, or have our own trade deficit grow even more. A weakness in the Chinese currency will increase more demand from the public sector, as the government is becoming more friendly to the idea of Chinese citizens owning the physical metal to protect the purchasing power of its currency.

Why such a focus on negative news in relation to gold in the West, even as demand for the metal explodes in Asia? The mainstream media, by focusing on the fall in the paper market, is helping trick many investors into buying new short positions, while major banks take the long side of the trades. Even so, with some 40 tons of gold being sold in just days, the difference between the paper and physical markets cannot continue for long, Maguire argues.

In a recent article published in Seeking Alpha, I wrote on the future prospects of the Chinese economy using copper prices as an indicator moving forward into the end of Q2 of 2013. I said, "Looking forward, China's planned infrastructure projects should begin to strengthen copper demand in the third quarter of 2013, said Li Yusheng, senior copper market analyst at Chinese state-owned metals consultancy Beijing Antaike. And while Mr. Yusheng doesn't see any fresh stimulus announcements in 2012, he said new measures should be launched in 2013, most likely in the form of spending on railways and power grids.

Morgan Stanley forecasts that copper prices will advance 7.6% in 2013 from last year as demand in China, the U.S. and even Europe is forecast to rise amid a supply deficit for the metal. Morgan Stanley raised its Chinese copper demand forecast to 8.4% year-on-year from 6.7% and expected further 5% growth in 2014. "China's industrial production cycle turned up in the fourth quarter of 2012, with infrastructure-related demand and non-ferrous metal output contributing strongly to increased output and higher orders," the analysts said. "We believe this improved position will strengthen further in 2013, particularly as widespread industry destocking of finished products appears to be ending." Global demand will exceed supply by 17,000 tons in 2013, the fourth straight annual deficit, it said.

Like Maguire, who argues that we are witnessing a historic time in metals, which we will look back on and wish we had been in the market with far more long positions, the technical analysts at the Equity Management Academy and I also believe that physical gold bullion is being positioned for a historic move up as the paper and physical markets diverge. When the crack between the physical and paper markets widens and then the two separate in the near future, the price of physical gold will reach historic highs.

On May 9, 2013, a report that China's trade surplus was $18 billion instead of an expected $15.6 billion sparked a $24 spot gold rally. Such Chinese influence on the gold market is bound to increase as China's economy continues to grow in relation to the rest of the world.

Although the fundamental and technical arguments for rising gold prices in the long term appear strong, the current manifestation of the gold market is a young one and predicting the future can be fraught with peril. Between 1933 and 1975, Americans were not even allowed to own gold. When the ban was lifted, the government-set price at $35 an ounce was left far behind and gold soared to $850 an ounce by 1980 as the US and much of the global economy languished in the 1970s. Even with no ban after 1975, however, trading gold in the United States was difficult. Gold jewelry and gold coins could be bought and sold, but it was far from easy, let alone convenient.

Today, trading gold is as easy as trading stocks. With the Internet, it has also greatly eased the difficulty of buying and selling physical gold. This checkered history suggests that government intervention, either in the United States, China or India, the major players in the gold market, could completely alter the trajectory of the price of gold, both the paper and physical prices. Such government intervention would probably be the result of a crisis, such as the current economic crisis. The government seizure of deposits in Cypress banks suggests that seizing gold from citizens might not be that far away, if the crisis worsens. This seems unlikely, but so did the 2008 financial meltdown. If you do buy physical gold, it might be wise to hold it overseas or somewhere far from the prying eyes of a government, should the worst happen.

A more probable worry about investing in gold is the fact that even with the recent pullback, gold above $1,400 an ounce is still trading far above where gold traded from 1980 through 2006, when the range was between about $50 and $850 an ounce. In the past 12 years, gold has risen, with intermittent pullbacks, more than three-fold. Apart from any other fundamental or technical arguments, a strong case could be made that gold is still trading at far above where it should be historically. With limited industrial applications, for the most part gold is an investment which is only worth what someone else is willing to pay for it. If the current economic troubles ease, the rush to gold out of fear could abruptly end, which could trigger a major drop in gold prices. As I've argued in other articles, however, the current economic situation with increasing global debt levels, the massive printing of money and failing banks in Europe, seems far from rosy. Fear about the future and the rush to gold appears to be unlikely to abate any time soon.

The current downturn, even with all I have argued above about my belief that it will turn around, could worsen. If investors who have been in the gold market for a long time start to sell to take their profits off the table for fear the bear market will continue, it could accelerate gold's decline. At this point this does not appear to be happening, but with wide-spread media coverage of gold's fall and many investors getting worried, a turn to a raging bear market after more than a decade of a bull market in gold could occur. I believe such a scenario is unlikely, but investors should be aware of the possibility.

Let's take a closer look at the Gold Trust Shares ETF gold derivative instrument and see if we can identify some live trading opportunities for next week.

Gold holdings in the SPDR Gold Trust suffered net outflows of $6.77 billion in April, with losses for the year to May 8 at $14.67 billion, according to recent data from IndexUniverse.

Daily Outlook

The GLD SPDR Gold Trust Shares closed at 139.60. The market closing below the 9 day MA (141.48) is confirmation that the trend momentum is bearish. A close above the 9-day MA would negate the daily bearish trend to neutral. With the market closing above the VC Weekly Price Momentum Indicator of 140, it confirms that the price momentum is bearish.

Look to take some profits, if long, as we reach the 142.65 and 145.51 levels during the week. Buy corrections at the 137.10 to 134.41 levels to cover shorts and go long on a weekly reversal stop. If long, use the 134.41 level as a weekly Stop Close Only to go neutral. Our models indicate a bottoming action is taking place and caution is warranted on the short side.

Weekly Outlook

With the week's lows of 137.26 not violated by closing below this level on a weekly basis, we can build a strong argument that the lows are in and the foundation is in place to support a bigger and stronger move to the upside. If not look for more basin and bottoming action from these levels.

If the lows of this week hold, it will support a rally into the following Fibonacci targets short-term:

1. 146

2. 150

3. 155

A weekly close above 155 puts into perspective the upper end of the target zone, the highs (186) made in September 2011.


Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in AGOL, AGQ, DGL, DGLD, DGP, DGZ, DZZ, GLD, GLL, IAU, PHYS, SGOL, UBG, UGL, UGLD over the next 72 hours. 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: The information in the Market Commentaries was obtained from sources believed to be reliable, but we do not guarantee its accuracy. Neither the information nor any opinion expressed herein constitutes a solicitation of the purchase or sale of any futures or options contracts.