Investors can be split over the worthiness of investing in gold, but there are three forces to keep an eye on that could light a fire under the price of gold over time.
Gold bulls got kicked in the teeth on Monday when Don Kohn — who is on President Obama’s short list of candidates to replace Fed Chairman Ben Bernanke — sent around a note saying the Federal Reserve will begin “tapering” its QE program after the September meeting.
That news sent gold lower on the day, and could grease the skids for the yellow metal for another week or two.
It doesn’t take much of a crystal ball to see that the Fed has been playing good cop/bad cop with the markets for months. First, we’re told quantitative easing will wrap early, and then we’re told they’ll extend QE until monkeys fly. It’s silly. But like Charlie Brown and the football, traders go for it every time.
Personally, I’m glad for every short-term pullback in gold and silver, because I’m using those dips to buy more.
Looking at the chart, you can see that gold is between support and resistance. I don’t expect gold to get much cheaper, because it’s already below the average cost of production for the big miners. And I think gold could rally to $1,440 once traders shake off short-term fears.
Longer term, I’m very bullish on precious metals. Let me tell you about three things that could light a fire under the price of gold over time.
The Fed would like you to ignore these forces … but you ignore them at your peril.
Force 1: 7 trillion reasons to buy gold
Asia sits on almost $7 trillion in currency reserves, much of it in dollars. China alone holds $1.3 trillion in dollars. Japan holds another $1.1 trillion. This is all fine and dandy as long as Asia keeps loading up on dollars. It helps Uncle Sam support his high-living lifestyle. The problem comes when Asia decides to stop stacking greenbacks to the rafters.
If Asia decides to bring just a small slice of those funds home — to “sell” U.S. dollars — it could spend the money on infrastructure, education, new tech, energy research and more. The only reason Asian central banks hold on to their dollars is they like to keep their currencies cheap to sell us boatloads of poorly made junk.
So if Asia finally dumps some dollars that would send the relative value of the dollar lower.
Gold especially should benefit, because China and other Asian countries are already loading up on as much gold as they can carry.
And that brings me to my second point…
Force 2: The big migration from west to east
The most bearish force in the gold markets right now is selling by exchange-traded funds that hold physical metal. Holdings are now at their lowest since May 2010. Barclays reports, “Net redemptions for the year-to-date have reached 653 metric tons, some 24% of holdings since the start of the year.”
Holy cannoli, that’s a lot of gold! It’s surprising that gold prices aren’t lower than they already are. And the reason for that is eager buyers are snapping up that gold even as the big funds get rid of it.
The question every investor should be asking is, “where is the gold going?”
The answer is simple: To Asia, especially China.
Reports of gold buying in China are anecdotal; we won’t have the hard figures on how much they’re buying until long after the fact. But we do know that:
• China’s May gold imports from Hong Kong jumped by more than a third from the previous month. So far, net imports through Hong Kong for the first five months of the year have totaled more than 413 metric tons — double those of a year earlier.
• Indians were buying so much gold that the government instituted draconian crackdowns on gold importation. The biggest growth industry in India right now is gold smuggling.
• Pakistan saw its own gold imports more than double. The value of gold imports in June recorded a jump of 176% compared to imports during June 2012. So, Pakistan announced its own temporary ban on gold imports.
Wall Street wants to pretend that gold is worthless, in order to keep up the pretense that all the paper money they’re printing still holds its value. So they’re selling gold on the cheap.
And Asia, particularly China, isn’t going along with the charade. The Chinese know that gold has real value. They’ll buy every gram that the SPDR Gold Trust (NYSE: GLD) wants to sell.
What the big banks really need gold for is to back up a currency when its value is questioned. That’s why the world’s central banks are buying a lot of gold right now. I wonder what the price will be when the Chinese sell our gold back to us.
Force 3: Future gold supply is imploding
The write-downs on gold projects this year isn’t just a disaster … it’s a catastrophe totaling $24.67 billion, according to Mineweb. Big miners trimmed operating mines, pushed back new projects and shut down mines that don’t work.
It’s so bad Barrick alone plans to sell, close or curb production at 12 of its 27 mines.
Not surprisingly, one major miner after another is reducing its production targets for this year. This will squeeze gold supply this year, and the squeeze will get tighter in future years as new projects are abandoned.
And that means there is a major opportunity coming up for smaller, low-cost gold producers. After all, the big gold miners are sitting on bags of money. They’ll need to deploy that cash… and they need to replace the high-cost projects they’re shelving.
These three forces are more than a push … they’re a potential rocket launch. When that big move higher comes, you’ll wish you owned more gold.
Sean Broderick is a resource strategist with The Oxford Club. To read more articles by Sean, visit here.
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