Over the past couple of years the price of gold has remained stubbornly low despite bullish factors that should be driving the price higher.
Two of these bullish factors stand out in particular.
The first is a rising money supply. Since the gold market peaked in September 2011 all of the major measures of money supply have risen meaningfully:
M0: $2.7 trillion to $3.6 trillion (+33.3%)
MZM: $10.3 trillion to $12.1 trillion (+17.5%)
M2: $9.5 trillion to $10.95 trillion (+15.3%)
The second is a significant accumulation of gold by central banks. Central banks have been aggressively accumulating gold as the following chart illustrates.
It seems that despite bullish fundamentals gold traders are playing the downside price momentum and are speculating that gold prices will continue to fall. But given the fundamental picture this is unsustainable. However it can continue for some time. Gold accumulators are patient and are willing to wait for prices to come to them even if they are extremely bullish.
What then will scare short sellers and create momentum to the upside?
Since it seems that more stable, long-term secular trends such as a rising money supply or central bank accumulation are being ignored, I have identified 3 catalysts that can spark positive sentiment in the gold market by refocusing the market's attention on these longer-term trends and away from downward price momentum.
1: An Increase In the Size of Quantitative Easing
Despite the notion that there will be "tapering," or a reduction in the rate of the Federal Reserve's bond purchases, there is no indication whatsoever that this will actually happen beyond excessive media and Fed propagation. Throughout the quantitative easing era of the Federal Reserve there have been several claims from the Federal Reserve that these programs are only temporary, and yet they have only gotten bigger and more permanent. Momentary cessations of the program in 2010 and 2011 have lead to market panics and immediate reinstitutions of the program.
Since the program hasn't stopped, and since it has only gotten bigger with time, there is no reason to believe that the pattern will change, especially given that uber-dove Janet Yellen will almost certainly be in charge of the operation. I am not the only one who holds this position. Marc Faber expressed it on CNBC two weeks ago. And he has been dead on in predicting this increasing onslaught of quantitative easing. He predicted a substantial increase in QE on Bloomberg in 2010. Peter Schiff asserted something similar on November 8th, and he too has correctly predicted an increase of quantitative easing in the past despite Bernanke's persistent claims that the measures were temporary.
I suspect that in the not too distant future that quantitative easing will be increased (and the increase will almost certainly be accompanied by hawkish language implying that the increase is temporary), and when the announcement is made this has the potential to spook gold shorts and spur buying throughout the world.
2: China Announces its Updated Gold Holdings
The People's Bank of China has undoubtedly been among the world's most aggressive buyers of gold, and perhaps the most aggressive. However it has not announced any changes to its gold holdings since 2008.
We don't know how much gold China has accumulated since this announcement, but there are ways of making rough estimates. Tyler Durden (pseudonym) of Zero Hedge estimates that China has imported 2,116 tonnes of gold since September 2011 from Hong Kong. While this figure doesn't account for exports, based on export data China has imported a net 1,000 tonnes. Furthermore, (net) imports don't include gold produced in China, which stays in China. The following chart shows net imports plus annual production and gives a rough estimate (about 6,700 tonnes) of the gold held in China.
True, not all of this gold is held by the PBOC: demand from citizens is high as well. But I suspect a great deal of it is going into PBOC vaults (speaking of which, according to Bloomberg they just bought one to hold 2,000 tonnes of gold).
It was five years prior to the 2008 announcement that China had previously announced an increase in gold holdings. Five years after the 2008 announcement the world waits for another, and by every indication the increase should be substantial - at least 3,000 tonnes, and perhaps as much as 4,500 or 5,000. This would be a significant catalyst for gold prices, and ironically the fact that such an announcement would be a catalyst is likely the reason that China, which wants to accumulate more gold cheaply, is withholding it.
3: A Reification of Gold's Monetary Role
There is a real possibility that one or more major trade deals will materialize in which gold is used as a medium of exchange. This has already occurred on a small scale with a trade deal between India and Iran, in which the former nation agreed to pay gold to the latter for oil in order to circumvent U. S. imposed sanctions on Iran.
This is a small-scale arrangement that doesn't materially impact the supply-demand dynamics for gold or the dollar. However it makes a symbolic statement - gold is money. In the future we could see another, similar deal, or an announcement by a nation that it is willing to accept gold as payment for goods, which would give greater legitimacy to the notion that gold is a currency, and one that is preferable to government issued fiat currencies.
The potential fall-out could be huge, especially if such a trade deal or announcement involves a large nation such as Russia, China, Brazil or Germany. To get an idea of what could happen to gold prices if this takes place consider what happened with bitcoins earlier this week on just the possibility that the virtual currency would be given legitimacy in the United States. Since gold is a much larger market than bitcoin I wouldn't expect a triple digit percentage move. But I think shorts would be forced out of the market if China or even Russia announced its preference for gold in international payments over dollars or Euros.
Just a couple years ago fear of a rising money supply and central bank accumulation were all given as reasons to accumulate gold, and yet here we are $650/ounce lower with all of these fears having come to fruition. The fact is that despite long term fundamental trends in the shorter-term the gold market is driven more by sentiment and momentum. While the bottom may not be in now is an excellent time to accumulate long-term positions in the yellow metal.
By far my favorite way of doing so at the present time is through shares of the Central Gold Trust (NYSEMKT:GTU), which trades at a 7.7% discount to its NAV, and therefore offers more value than the more popular SPDR Gold Trust (NYSEARCA:GLD). There are differences between the two funds, which i discuss here. Investors like myself who also want silver exposure can turn to the Central Fund of Canada (NYSEMKT:CEF), which holds both metals, and which trades at a 7.7% discount to its NAV.
Disclosure: I am long CEF. 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 own gold coins and select gold mining shares.