Central Bank Demand Still Supportive For Gold

Includes: GDX
by: Clif Droke

Gold's "fear factor" has faded somewhat, but not entirely.

Central bank demand for gold is still quite strong, however.

Together, safety demand and central bank buying will keep gold strong.

As has been the case with the stock market lately, investors’ collective concern over the global trade outlook has been the dominant driver for gold and the gold mining shares. And while gold may have temporarily lost some of its recent psychological support from the recent resolution of the U.S.-Mexico trade dispute, it still has plenty of support from other quarters, most notably from central bank demand. We’ll discuss this in today’s report as I lay out the case that gold and the mining stocks will remain buoyant in the coming months thanks in part to this support.

The recent price performance for both gold and the gold mining stocks has been satisfying to precious metals bulls, to say the least. August gold is now back above the psychologically important 50-day moving average as of the latest week (see chart below). This is an important technical consideration in that this widely watched trend line has served as a pivotal turning point identifier for gold’s important short-term and intermediate-term moves in the past.

August 2019 Gold

Source: BigCharts

Gold’s biggest support lately, however, has been from an even more widely watched source. To be exact, the tariff disputes with the U.S. and its leading trading partners have brought increased volatility to the equity market and at the same time increasing safety-related demand for gold. There’s now a concern, however, that with the latest truce that was declared between the U.S. and Mexico over trade tariffs, gold may have lost an important source of demand among safety-conscious investors. While this remains to be seen, it should be pointed out that there is still much uncertainty over the U.S.-China trade war which will undoubtedly keep gold’s “fear factor” in play.

Beyond safety-related considerations, however, there is another factor which should also bolster gold prices in the coming weeks and months. I’m referring to the recent news that China’s central bank has been buying more gold, continuing a 6-month buying spree in May. According to Kitco’s Allen Sykora, the People’s Bank of China increased its gold reserves to 61.61 million ounces in May, from 61.10 million in April, which amounts to an increase of almost 16 tons. China’s central bank has reportedly purchased 74 tons of gold since the end of November.

It should also be noted that central banks around the world have been steady buyers of the yellow metal in the last year. They collectively purchased 651.5 tons of gold in 2018, according to the World Gold Council. This amounted to the highest level of central bank gold purchases in nearly 50 years.

On the subject of central bank buying, an RT article points out that the world’s governments have been on a “gold-buying spree” of late. The putative basis for this increased gold demand is the belief that the dominant economic and political position of the U.S. may be ending. The article stated that central banks are among the biggest buyers of gold in 2019, having purchased 145.5 tons of gold in the year to date.

Tellingly, Russia is the largest buyer of gold after having sold 84 percent of its U.S. Treasury bond holdings, according to RT. Turkey, China, and Iran are also said to have sold off U.S. Treasuries and to have purchased gold with the proceeds. Political implications aside, the most important takeaway of the trend toward rising sovereign demand for gold is that the yellow metal has important long-term support which should keep prices buoyant in the months ahead. And while periodic short-term setbacks can still be expected, gold’s longer-term path of least resistance appears to be to the upside.

Meanwhile on the stock market front, investors seem to have taken the bromide “Sell in May and go away” to heart this year. And while stock suffered a setback last month, Wall Street’s pain has proven to be the gold market’s gain. More specifically, the stocks of gold mining and exploration companies have benefited from safe-haven demand as investors seek to leverage the upside potential of the physical metal by owning gold mining shares. Since the onset of June, gold stock prices have gained some 11 percent as measured by the PHLX Gold/Silver Index (XAU).

PHLX Gold/Silver Index

Source: BigCharts

Indeed, trading interest among the actively traded gold and silver mining shares has been rising, while the beaten-down shares of many gold producers are now on the upswing. The behavior of the gold stocks so far this month has led many participants to wonder if perhaps a bottom of intermediate-term (3-6 month) proportions is finally being established. While it’s still too early to assume that an intermediate-term turnaround has been launched, the odds currently favor the leading mining shares continuing to rally in the short term.

My expectation that the gold mining stocks will continue to enjoy strong support in June is based on the strong increase in short-term incremental demand for the gold shares lately. Specifically, the 4-week rate of change (momentum) in the new highs and lows of the 50 most actively traded gold stocks has turned decisively higher since late May and continues to rise on a daily basis (below). I rely on this indicator to inform me of the level of incremental demand for gold stocks. When this indicator is rising, the assumption I make is that the near-term path of least resistance for gold stocks is to the upside. The path for the gold miners is still a bullish one according to this indicator.

Source: NYSE

In summary, a combination of central bank gold demand and continued uncertainty over the U.S.-China trade outlook should support gold prices in the coming weeks. From a technical perspective, rising internal momentum behind the actively traded gold mining shares should also help propel gold stock prices higher in the coming weeks. In view of these factors, investors are justified in maintaining a bullish bias for gold and the mining shares.

On a strategic note, I’m currently long the VanEck Vectors Gold Miners ETF (GDX) using a level slightly under the $20.42 level (the May 29 closing price) as the initial stop-loss on an intraday basis. Investors can also maintain longer-term investment positions in physical gold. The latest weekly close under the 50-day moving average in the U.S. dollar index should help support the intermediate-term outlook for gold prices.

Disclosure: I am/we are long GDX. 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.