With gold breaking out of the large wedge we had been focused on, I turn my attention to the fundamentals. I return to the fundamentals of my trades at least once a week or sooner if some piece of information forces me to rethink my outlook. In the case of gold, my fundamental outlook for the metal and all of the precious metals (pmetals) has been bullish for almost a year now.
There was obviously some information I came across this week that made me rethink my gold long. The said piece of information was a report that the Chinese government was marketing funds to its citizens that invest in gold and silver, and maybe even other commodity focused investment funds. While this in and of itself is bullish for gold, silver, and/or commodities, when we dig even deeper into why they would be doing this it becomes even more interesting.
It has been no secret that the Chinese government has been stockpiling commodities to support their “stimulus plans.” While this could be partially true, they could be stockpiling said commodities as a way to hedge their foreign reserves against continued dollar weakness. We touched upon this idea before, but I have even more to add to this now.
Along with buying up copper, aluminum, etc., they were also actively purchasing gold, silver, etc. If the Chinese government has large reserves of physical gold and silver, could they help offset some of that dollar weakness by encouraging their citizens to purchase gold and silver? YES! As the Chinese government and its citizens continue to buy up these pmetals, they cause investors from around the world to take notice of the prices moving higher. These investors pile into the pmetals as well, causing the prices to continue to rise. All of this helps the Chinese offset their losses on foreign reserves due to dollar depreciation.
Gold, unlike most other asset classes, has the unique position of being the “fear gauge” among investors. If gold is rising in value it usually means investors are becoming risk adverse, so they see trouble ahead and are investing for safety/capital preservation. When gold begins to rise, it becomes a self-fulfilling prophecy as investors see the price of gold rallying and begin to question what it is that other market participants know that I don’t. They begin to worry and start to buy up gold as well. This eventually spills over into the BRIC countries and causes these citizens to start buying gold as they have a reason to fear as their currency has collapsed before. I am coining this phenomenon the “golden spiral.”
Lastly, the members of the G-20 also assured the world that they would keep economic stimulus measures in place. This is bullish for gold as these countries continue to spend and debase some of their currencies. Quantitative easing (printing money) has the potential to cause elevated levels of inflation down the road and this aspect of “stimulus” is one of the largest bullish components of the argument for being long of gold.