Gold: Has The Bull Started To Run Again?

Includes: GDX, GDXJ
by: Dave Kranzler

In my last article I had suggested that gold had found a bottom at $1200 and that there was a likelihood that enormous demand for physical gold from China would drive the price higher this year. On the day it was published (January 28), the price of gold was at $1250 (Comex front-month basis). Eleven days later, gold is 3.6% higher at $1295, with most of that move in the last three days. While I was not expecting the long term bull trend to reassert itself this quickly, China returned last Friday from its week-long observance of the Chinese New Year and has continued buying gold at 2013's record-breaking pace. Moreover, it looks like India may shortly ease its restrictions on gold imports. Both factors combined could easily drive the price of gold up to the $2,000 level that I forecasted in my last article.

In my view based on studying and trading gold on a daily basis, it definitely seems to be behaving a bit differently. The intra-day profit-taking sell-offs are not as steep and the price seems to bounce back more quickly. This 20-yr monthly chart of gold can add some perspective:

I like using a long-term monthly chart in analyzing trends because it "cleanses" out the day to day "noise" and volatility. As you can see, based on the monthly pattern, gold is still in a long term bull trend pattern that started with the $255 low of March 31, 2001. You can see gold has had a couple of corrective sell-offs during this period, each of them roughly the same in percentage amounts as I detailed in the article linked above.

There are what I believe two compelling features on this chart. First the extreme oversold condition of gold as shown by the RSI and MACD (black circles) momentum indicators. At no point in the last 20 years has the gold market been this oversold. The second attribute is the bullish bounce off of the long term trend line of support (black line). Whether or not this ends up being an oversold bounce that turns into another leg is open for debate and remains to be seen. But the fact that the RSI indicator has already turned back up (top black circle) somewhat confirms that the long-term price momentum has shifted back to the upside. My interpretation of the graph above, and which is supported by strong demand fundamentals as I'll detail shortly, is that gold has finished its price correction to the downside and is getting ready to make a big bull move higher.

In terms of the fundamentals, let's take a look at the supply/demand aspect of the physical gold market. As I showed in my previous article, 2100 tonnes ("tonnes" is a metric ton, which is the conventional measure of the global market) of physical gold were delivered into China via the Shanghai Gold Exchange (SGE) in 2013. That's a rate of about 40 tonnes per week. In the first four weeks of 2014, an average of 54 tonnes per week were delivered. Many might have explained this as a buying push ahead of China's week long celebration of the Chinese New Year. However, after being closed last week, the SGE has delivered 59 tonnes of gold in the first three days this week, with 29.5 tonnes delivered last night (Wednesday night). So far based on these numbers - in the context of the amount of gold delivered in January, it would appear as if the rate of gold buying in China could increase this year over last year's record amount. If this is the case, it will put significant upward pressure on the price of gold.

The other side of the China's influence on the demand for gold is the supply. The world produces from mines about 2300 tonnes of gold per year. Although, with several large miners announcing mine closures due to the low price of gold during 2013, it is likely that 2013's production level will be closer to 2100 tonnes - about equal to what was delivered on the SGE. This leaves a supply hole in 2013 for the rest of the world that was largely filled by the 1000+ tonne reduction in gold from the various physical gold ETFs, the Comex and Central Bank gold leasing. The fact that China's demand for physical gold is putting pressure on physical supplies is evidenced by the recent negative GOFO (Gold Forward) rates being observed on the LBMA (London Bullion Marketing Association). I explain what the GOFO is and the significance of negative GOFO rates in this article.

Briefly, when there's a shortage of gold available from the LBMA to be delivered, the bullion banks (LBMA market-making banks) will pay holders of gold bars to borrow the bars. The banks "cover" this borrow by buying gold forwards (similar to futures) for the delivery of gold in the future. That gold is then returned to the holder who had loaned out its gold. The 1-month GOFO rate went negative in early February. Two days ago it went negative out to three months and the negativity of the 1-2 month rates have been steadily increasing. The reason this occurs is because there is increasing demand from the bullion banks to source/borrow gold which can be delivered to buyers. If China's demand for the first 6 weeks of 2014 continues going forward, we can expect to see even higher negative GOFO rates and ultimately a much higher market price of gold. I have always believed that eventually the demand from the physical gold market would begin to drive the price of gold a lot higher and we may be seeing the start of that process.

One last demand factor could have a significant upward influence on the price of gold. As most of you know, the Indian Government slapped import controls on gold imported into India last summer ahead of India's biggest seasonal buying period of the year. This sharply reduced the amount of gold imported into India in 2013, which was on pace for a record year of gold imports. The import controls were designed to curtail India's rapidly increasing current account deficit. Yesterday it was reported that India's trade deficit had declined enough that the trade ministry recommended easing the gold import restrictions. If the Government follows through on this recommendation, it will likely trigger a huge amount of buying. This is especially the case as the spring marks India's second largest seasonal buying period. In other words, if India's pent-up demand is layered onto China's current buying, it could trigger a big move higher in the price of gold, which is what would be required to slow down demand in order to balance out supply and demand.

As outlined above, gold is still in a long-term bull market pattern which is firmly supported by fundamental supply/demand factors. On the assumption that China continues importing gold at the rate it has been importing gold so far this year, I expect that China's demand alone for gold will drive the price higher. If India's gold import volume becomes a factor, I am confident that there's a good chance my $2,000/oz gold target for 2014 will be realized.

You can look through some of my past articles for some ideas on how to take advantage of a big move higher in the price of gold. One factor I will discuss in my next article, and which is a factor that reinforces the bull view of gold, is the recent move being made by the mining shares. While YTD the price of gold is up 6.9%, the Market Vectors Gold Miners ETF (NYSEARCA:GDX) is up 18.5% and the Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) is up 30.1%. On the basis that share prices tend to move higher in reflection of an anticipated growth in their underlying source of profit - gold in this case - the mining shares so far are confirming my forecast for a higher price of gold. Several of the junior stocks we own in the fund I manage and am invested in have seen gains this year so far of 50-100%. For me this further confirms that the market is anticipating a much higher price of gold this year.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within 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 hedge fund I manage is long physical gold, silver and mining stocks. I am invested in this fund.

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