Gold Bulls Need a Reality Check

by James Brumley | May 20, 2013 8:54 am

Contrary to the World Gold Council’s spin on the matter, demand for gold during Q1 2013 was noticeably weak.

The headline to the group’s quarterly update on gold usage[1] read “Global demand for gold jewelry up 12% in Q1 2013 driven by significant increases in India and China.” It was a cherry-picked data point, however. In reality, last quarter’s total consumption of gold — by tonnage — fell 18% from the total used in the fourth quarter of 2012, and it rolled in 14% below consumption levels from the first quarter of 2012. There’s just no getting around the fact that demand fell — significantly.

But that’s not even the scariest part for gold bulls.

Uh-Oh

What fans of the world’s most popular metal are going to have to emotionally and mentally process is the 177 tons of gold the ETF industry had to sell, on a net basis, in the first quarter to satisfy fund redemptions. That’s not only the first time since 2007 that the ETF industry was forced to be a net seller, but it also was a dubious record-breaker, not to mention particularly startling for an industry that up until this point had been buying about 91 tons per quarter. Gold investors clearly experienced a major change of heart.

It gets worse.

Not that the group was a net-seller of gold in the first quarter of the year, but the world’s governmental banks (a.k.a. central banks) significantly curtailed their purchases of gold in Q1, from 145 tons in the fourth quarter of 2012 to 109 tons this time around. In fact, it’s the lowest level of quarterly gold purchases that central banks have made for the past two years, perhaps pointing to a mentality of “we have enough already.” If that’s the mind-set, it might just be part of a bigger transition into a “we have too much” mentality … the beginning of net-selling from the globe’s biggest banking entities.

golddemand Gold Bulls Need a Reality Check[2]

Sure, it’s possible last quarter’s weak buying effort from government banks was an anomaly. If it wasn’t, though, the fact the world’s central banks have amassed more than 1,200 tons of gold since this point in 2009 should be more than a little concerning. If and when the banks do become net sellers again — like they were between 2006 and 2008 — that much supply could absolutely hammer gold prices. See, we only consume an average of 1,100 tons of it per quarter, and most of that supply is already met by mining activity.

Oh, and the central banks have an ever-strengthening reason to question why they’re buying or holding so much gold now.

The Solution to a Nonexistent Problem

If you’ll recall, the whole reason the world was infected with gold fever beginning in 2008 was the “easy money” policy from our central banks. In an effort to stimulate industrial and financial activity, the Federal Reserve flooded the economy with cheap dollars while simultaneously pushing interest rates down to nothing — a move largely mirrored by most foreign governments. Though effective, the maneuver tends to have a nasty side effect: inflation. Indeed, given just how drastic and big the stimulus effort was at the time, many presumed inflation would be rampant, and that gold would be the only way to keep up with soaring inflation rates.

inflationgold 300x220 Gold Bulls Need a Reality Check
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That inflation never materialized. In fact, we’re closer to the opposing problem of deflation.

In addition to the World Gold Council’s first-quarter report Thursday, the Bureau of Labor Statistics announced that, as of April, the annualized inflation rate (CPI) has fallen to a mere 1.06%. That decline extends the broad downtrend into its 19th month, leaving some to wonder that if we haven’t seen significant inflation yet, will we even see it at all? As was noted, we’re closer to deflation than we are to inflation, and the Fed is already rumored to be looking for a way to dial back its stimulus efforts — a decision that would only further crimp healthy inflationary pressures.

dollargold 300x242 Gold Bulls Need a Reality Check
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Meanwhile — and somewhat related — the American greenback continues to rally, sapping the value of gold. (Gold is, unfortunately for some, priced in U.S. dollars).

The rise of the U.S. Dollar Index is something of an X-factor for traders. The sawbuck’s relative value is driven by forces like domestic inflation and our interest rates, but it’s also dictated by inflation, interest rates and economic strength of other nations’ economies. In other words, no one can fully control the dollar’s value — it’s a relative value established by an auction-based foreign currency exchange market.

That’s a problem for gold’s bulls too, since the underlying factors pushing the dollar higher don’t look like they’re going to end anytime soon.

Bottom Line

goldfutures 300x178 Gold Bulls Need a Reality Check
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While the bigger-picture details discussed above examine the long-term undertow, none of that alters gold’s short-term ebb and flow. With that in mind, know that gold is still holding above a key floor at $1,332 per ounce. That was where gold bounced in April and also where it bounced in January 2011 right before the rally really turned up the heat. Although gold futures are starting to trend lower again as of this week, the bearish undertow will only matter if and when the support at $1,332 is broken. If it does fail to hold up as a floor, the next likely stopping point is a zone of support and resistance around $1,060.

As nice as it would feel to talk about gold’s technical upside here, it’s really not part of the equation; traders are still pounding the metal. Of course, the metal’s fundamentals leave little doubt as to why. It would take a move above $1,500 for the market to even think about getting that ball rolling, and it was all the bulls could do to test $1,487 a couple of weeks ago.

As of this writing, James Brumley did not hold any gold-related positions.

Endnotes:
  1. group’s quarterly update on gold usage: http://finance.yahoo.com/news/global-demand-gold-jewellery-12-121500616.html
  2. [Image]: http://investorplace.com/wp-content/uploads/2013/05/golddemand.png

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