Seeking Alpha

Sovereign Demand Is Good News For Gold Bulls

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Includes: GDX
by: Clif Droke
Summary

China's People's Bank has been on a gold buying spree since December.

Russia's central bank has also been a heavy buyer of bullion.

Central bank demand will keep gold's long-term bull market healthy.

Gold is getting an increasing amount of support from central banks. Following a major buying spree, China’s People’s Bank is but the latest sovereign power to add to gold’s long-term support. In this report, we'll look at the reasons why the growing sovereign demand for gold will extend the metal’s bull market well beyond the current year.

In a global economy threatened by intermittent financial market volatility, the threat of an all-out trade war, and various geopolitical uncertainties, fear is the dominant motive for most investors. What’s more, capital preservation has taken precedence over capital gains since last summer when trade war fears first came to the fore. For that reason, gold has been a top choice for a growing list of participants.

Among the growing number of investors who are attracted by gold’s potential are institutional players. Institutional asset managers recognize gold as not only an ideal anchor for conservative portfolios but also as a long-term growth opportunity. But gold’s allure has expanded even further in the past year to include central banks. With the global economy looking shaky, banks have become major players in the gold market once again. After years of dormancy, central bank bullion purchases have become an integral part of the metal’s demand profile.

The latest reminder of central bank activity in the bullion market was provided by a Bloomberg article which highlighted China’s addition of more than 100 tons of gold to its reserves since last December. This serves to underline China’s position as one of the world’s premier sovereign buyers of the precious metal, and the news was welcomed by gold investors everywhere.

According to Bloomberg, the People’s Bank of China added more gold in September, increasing the bank’s holdings to 62.64 million ounces. The latest inflows translate into 5.9 tons and follow the accumulation of nearly 100 tons over the previous nine months. The dramatic rise of inflows into China’s official gold reserves is shown in the following graph.

China

Source: Bloomberg

Gold prices hit a multi-year peak in September, partly as a result of China’s heavy buying, as the following graph illustrates. Trade war fears have prompted China’s government to increase its gold reserves as economic uncertainty has grown to the point where defensive strategies have now eclipsed the focus on growth among China’s top officials.

Gold Continuous Contract Source: BigCharts

China isn’t the only sovereign player to show interest in gold, however. Russia’s central bank has also been a major buyer of gold bullion lately. According to the World Gold Council, Russia’s central bank reserves were at 2,219.2 metric tons as of September. China’s total holdings, by comparison, are reportedly 1,936.5 metric tons. Analysts believe that the biggest motives for central bank gold demand include the need to diversify, as well as hedging purposes.

Not only are central banks supporting gold as buyers, they’re also providing support for gold prices through loose monetary policies. Joining the U.S. Federal Reserve in cutting interest rates is the European Central Bank (ECB), which has announced its intention to launch another bond-buying program. The ECB said last month that it would buy $22 billion in bonds and other financial assets starting in November. The ECB further assured investors that it would continue its stimulus policy “as long as necessary.”

On a related note, the European Commission has published a discussion paper for finance representatives of the 19 member countries of the euro zone, which meet this week in Luxembourg. According to a Reuters report, the paper recommends preemptive fiscal stimulus from richer members of the eurozone like Germany and the Netherlands. Failing to do so, the paper warns, will result in an extended period of low growth.

A coordinated loose money policy on the part of the world’s governments and central banks can only extend gold’s bull market from a longer-term perspective. Some of gold’s best years were in the wake of the 2008 credit crisis when central bank easing was in full force. Gold historically responds well to easy money policies, which typically serve to diminish gold’s competition from interest-bearing assets through lower interest rates. The “easy money” created by central banks also tends to flow into gold as investors believe the very need for fiscal and central bank stimulus is a reason to be concerned for the economic growth outlook. As recent history reveals, the slightest hint of worry only serves to bolster gold demand based on the metal’s “fear factor.”

With central banks continuing to add to their gold reserves, the gold price will have a significant support in the coming months. Investors who may be worried that gold’s recent stumble is the start of a renewed bear phase should realize that the metal’s supply/demand profile is as strong as it has been in years. Thanks to a combination of an ever-increasing “fear factor” and sovereign demand, bullion is poised to continue its bull market well into 2020. Investors are therefore justified in maintaining longer-term investment positions in gold.

On a strategic note, I’m waiting for both the gold price and the gold mining stocks to confirm a breakout before initiating a new trading position in the VanEck Vectors Gold Miners ETF (GDX), my preferred trading vehicle for the gold mining stocks. I’m currently in a cash position in my short-term trading portfolio. However, GDX closed decisively above its 15-day moving average on Oct. 8, and is very close to confirming an immediate-term (1-4 week) bottom per the rules of my technical trading discipline.

Disclosure: I/we 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.