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An Artificial Dullness

Author: KP Jeewan/Thursday, May 1, 2014/Categories: Gold

An Artificial Dullness

Exactly a year ago, gold witnessed the sharpest price decline in a decade. From $1500 levels, gold crashed to $1300 or so in a matter of hours.
The correction was analysed threadbare and the responsibility pinned firmly on the general disenchantment of investors with the yellow metal after years of bullishness. As the possibility of turmoil in financial markets receded in view of recovery in US markets, the need for investment in a safe haven such as gold also went down.
There were aggressive bearish calls from various well known global investment banks with targets ranging from $1100 to even $800 per troy ounce. It hit a low of $1180 on 26 June 2013 and retested the level yet again in December 2013.
Has the bull run in gold well and truly over? If yes why is still hovering around $1300 and not down to $800, the lower end of the pessimistic predictions?
The bull run in gold started in late 2008 as the world suddenly woke up to collapse financial system built on leverage. Sky high asset prices without the backing of fundamentals, collapsed in a heap.  In the ensuing panic, gold seemed like only asset class worth hiding in.
Fast forward to 2012, concerted efforts by central bankers and unprecedented money printing arrested the recession. Euro zone, which was tottering on the brink, finally seemed to escape the apocalypse. 
For many people, the need to hold on to gold as insurance against dud investments did not seem necessary. Asset classes such as equities started looking attractive once more. As usual, the institutional investors were first to jump ship and pile on to riskier assets.
Still, not everyone gave up on gold. Demand for physical bullion remained strong. China overtook India as the largest importer of gold. Many central bankers used the dip to stock up their reserves with gold.
While the data and stock markets point to a gradual recovery, the underlying global economy and financial system continues to be fragile. Hence people are still wary of completely abandoning gold.
While the above reasons explain why gold continues to attract buyers, the question still arises why it is not bouncing back strongly.
The key reason is that India, the largest importer which consumes 25% of total global demand, has been artificially kept out of market. After years of disuse, the old smuggling network is not efficient enough to cater to the demand. Not to mention, the taxes imposed on old purchase. The government knows this is not a sustainable situation. Once the smuggling network regains its form, gold will not be the only commodity to benefit from the channel. Hence it is a matter when and not if the restrictions will be removed. The day the announcement is made, we will see gold hit its upper circuit filter (if there is one).
Experts in the past have made mistakes about the Indian demand pattern. Unlike the normal asset classes, Indian consumer does not chase momentum in case of gold. A big chunk of investment is for consumption and is never to be sold. Hence the only thing that matters to her is the price. If smuggling is not rampant in gold currently, it is because the price for average consumer still hovers around Rs 3000 per gram. When it had dipped to Rs 2400 last April, we saw long queues outside jewellery stores.
Letting this demand into the international market should logically drive the prices sufficiently high to restrain the kind of demand we saw last year.
The gold story is not over by any means. Here is why we think so:
The unprecedented money printing by central bank can result in three outcomes.
If They Fail: This would result in collapse of fiat currencies. The impact on gold is easy to imagine.
If They Succeed:  All the money printing has only one stated objective, higher inflation. Only, governments tend to believe that they will be able to restrain inflation before it becomes an epidemic. Can they? I tend to think when inflation does rear its head, given the scale of money printing, it is going to be far more difficult to contain. A high Inflation scenario can only be bullish for Gold.
 If They Neither Succeed Nor Fail:  We sort of drift around like we are currently. Having come this far, the central bankers cannot give up. Any weakening of macroeconomic data would result in currency printing presses working overtime.
None of the scenarios is bearish for Gold. In addition, what looks like likely this year is competitive devaluation of currency by export dependent countries as the global trade pie shrinks. Japan and China are already doing it and the European Union has threatened doing it.
So will gold witness a renewed rally? Given the optimism on economy, gold is unlikely to be the preferred investment option in the short run. At the same time it is not advisable to exit the asset class either. The best option will be to continue accumulating on any dips, or when prices slide to Rs 2400 per gram levels.
The behaviour of the Indian rupee does have a significant impact on domestic price of gold. In the short run, the flood of FII inflows can trigger appreciation. But long term structural flaws, which indicate weakness, will continue to be there and would take many years to correct.
Gold dipped from a high of $1920 in September 2011 to a low of $1180 in June 2013. Technically speaking, the move corrects almost 61.8% of the entire rally from October 2008 to September 2011. The support therefore is a technically valid level from which the resumption of original trend can occur. 
The price pattern has subsequently given a series of higher high and higher lows to justify short term trend as bullish. If it manages to breach $1433, the medium term outlook will turn bullish. A breach of the low of $1180 can result in drop down to $956 levels.

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