Seeking Alpha
Richard Cox, Market Bulls (58 clicks)
Macro, commodities, medium-term horizon, contrarian
Profile| Send Message| ()  

Gold has rallied since the beginning of July but prices remain well below recent averages, and these cheaper market valuations have prompted a surge in jewelry purchases in Asian markets. And when we look at the broader price trajectory seen for most of this year, investors with positions tied to precious metals will need to take these changing trends into consideration going forward. For example, precious metals demand in Indonesia has reached its highest levels in four years as buyers take advantage of market weakness. Add to this the country's steadily expanding middle class, and this creates a supportive macro environment for the longer term outlook in the metal. Gold consumption in Indonesia is expected to rise to 40 metric tons in 2013, which is a 30% increase from what was seen last year - a clear sign that demand trends are changing in the region.

Given its traditional position as a hedge against inflation this activity is not altogether surprising. Consumer prices in Indonesia are rising at an annual rate of 8.6%. This well above prior estimates and the highest level since 2009. Slowing growth in Indonesia is making it difficult for the central bank to attack the problem by raising interest rates, and individual investors see few alternatives but to hedge with positions in gold. But what is most important about these types of stories is that they are indicative of the wider trends seen in Asian metals markets.

Balancing the Positive and Negatives

More broadly, this year's bear market in gold came as stock rallies cooled demand for safe haven assets, and sales in precious metals ETF reached new records. At current levels, gold prices are 19% lower than they were at the beginning of the year and 29% below the record highs posted in September 2011. This ends a 12-year streak of bullish yearly performances, and has left many investors skeptical in their assessments of what this means for the underlying trend. Since the June lows, however, the metal has rallied 15% and demand in China and India will likely approach 1,000 tons in 2013. In the first half of this year, gold purchases in India were higher by 48% at 568 tons, and this was beaten by only China where 571 tons (a 45% increase) were bought during the same period.

But in order for these trends in physical demand to solifidy a long term bottom in gold, we will need to see progress in ETFs like the SPDR Gold Trust ETF (GLD). Near term, this is unlikely given the massive selling activity we have recently seen from larger investors like George Soros and John Paulson, and global holdings in these types of funds have fallen by more than 25% this year. Further upside limitations will be seen if the Federal Reserve makes the decision to start phasing out on quantitative easing stimulus in September, as this will encourage buying activity in the U.S. dollar.

Other, more bullish, factors to consider can be seen in the supply constraints likely to result from mining company write-downs. Gold production is unsustainable for many mines when market valuations are below $1,250 per ounce, and this year's drop below this level has led to reduced output or outright closure at many production sites. So while the balance of the recent activity has been to the bearish side, it is important to remember these more positive factors as the broader effect is likely to be a less one-sided trajectory in GLD near-term.

GLD Chart Perspective

Ultimately, the balancing act between these positives and negatives should lead to a stabilization in market activity, and prevent gold prices from hitting new lows this year. From a chart perspective, the SPDR Gold Trust ETF has broken important technical resistance levels at 130.70, which takes pressure off of the downside and suggests elevated range trading into the latter parts of the year. Prices are still well below the 100-week exponential moving average, which indicates negative momentum.

But resistance above is relatively thin and there is plenty of room for upside extension. On the fundamental side, the latest upward changes in price momentum are supported by increased physical demand in Asia and potential supply limitations at key production sites. These factors will help balance some of the negatives seen at the beginning of the year and support arguments for a more bullish case for gold in coming months.

Source: GLD: Asia Demand Vs. Fed, ETF Sales