Commodities: Is gold rise just a dead cat bounce?

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Gold has been rallying from its three-year low of just off $1,180 an ounce in June. On Friday, it closed at $1,378.

What is driving this tentative recovery in the market for the “safe haven” metal? A key factor may be that the sell-off in exchange-traded funds backed by gold has passed its worst.

“Support has come from the financial market turmoil in emerging economies, geopolitical tension in Syria and Egypt, together with the fact that gold holdings in exchange-traded products has been stable for a couple of weeks,” says Ole Hansen, head of commodity strategy at Saxo Bank.

“[That] could be taken as a sign that most of the institutional selling may be over or at least paused.”

John Paulson, the legendary hedge fund manager, may have more than halved his stake in the world’s biggest gold-backed exchange traded fund (ETF), the SPDR Gold Trust, in the second quarter of the year but this has not dampened investors’ spirits.

That may seem counterintuitive, after all, people watch what Paulson and his peers do in the hope that they represent the “smart money” to follow. However, some traders blame gold’s fall to its low on the last day of June on selling by these gold-backed funds to meet clients’ request to exit their positions.

Some now hope funds are close to finished in terms of selling their gold, after an outflow of 402 tonnes from ETFs over the quarter. To put that in context, that wiped out the bulk of the buying by ETFs across 2011 and 2012 put together.

Meanwhile, outside the investment world, Indian and Chinese demand for gold has been strong, while the fall in the price has likewise stimulated retail investors to buy gold bars and coins.

Together, consumer buying of the metal rose by 53pc to a total 1,083 tonnes in the second quarter of this year compared to 2012, the World Gold Council reported in its latest quarterly update.

That left overall global demand at 856 tonnes, 12pc below its level a year ago, according to the Council’s figures.

Some think that if the heavy selling period is over, the gold price has quite a bit further to rally, up to $1,450 an ounce or above. And yet, it still looks risky to call this anything more than potentially a short-term floor for the price.

Why? Look to the Federal Reserve again. The gold price plunge in recent months has been largely driven by the expectation that the US central bank will start to unwind its vast quantitative easing (QE) effort, which, given its inflationary effect, puts some lustre on gold as a store of wealth. On a broader level, the backdrop of an improving global economy which allows the Fed to unwind QE further erodes the appeal of gold as a hedge.

Of course, when the Fed will act is not totally clear. On Thursday the minutes of its latest monthly policy meeting led people to take differing views on when the wind-down of purchases the so-called “taper” will begin.

Analysts at Morgan Stanley (Xetra: 885836 - news) saw the “key takeaway” as being that the Fed remains on track to taper its QE purchases in September.

“Fed officials are well aware that market participants generally see a September announcement of a start to QE tapering as likely, and they did nothing with these minutes to warn investors away from that view”, they said. “In our view, the recent gold price rally will likely fade towards year-end as the headwinds that have pressured gold throughout the year re-emerge.”

These are, in their view, a strengthening dollar as QE is removed driving up bond yields, which lessen the attraction of holding gold, which is a non-yielding asset, and “a continuing erosion in investor faith” in the metal.

Still, there is nothing like agreement in this area, with Saxo Bank making the call that QE tapering is a “temporary sideshow” which will be followed by “more QE coming in 2014, not less” on the back of negative economic data.

All that is clear is that the Fed holds the gold price in its hands.

= Chinese burn =

China will import more oil than the US within four years, according to energy consultancy Wood Mackenzie.

The Asian nation will spend about $500bn (£322bn) on oil imports by 2020, the consultancy calculated, as US imports continue to decline because of the country’s tapping of unconventional energy sources such as shale oil through fracking.

“China’s energy demand has been on a strong rising trend, a consequence of its economic growth,” the commodities research group said. “A lack of sufficient domestic oil resources to meet demand means China must turn increasingly to imports to satisfy its oil needs.”

Wood Mackenzie said that China faced the risk of becoming similar to the US of old, with oil import costs rising along with increasing dependency on OPEC.

“The US is adjusting to its ‘new normal’. Recent years of weak to declining US oil demand coupled with increasing domestic crude oil production and oil product exports has and will continue to facilitate a precipitous downward trend in crude oil imports and a precipitous decline in net oil imports,” the report said. “Unlike China, US import costs are falling, as is its dependency on non-North American crudes.”

In July, China’s oil demand rose 6.6pc to 9.82m barrels a day, Platts said last week.

= Silver =

The silver price has continued to rally from lows earlier this year, rising 28pc since its nadir and outpacing the 16.3pc rise in the gold price from lows. But can this outperfomance continue?

Silver bulls argue that the price recovery will receive a further boost as industrial demand for the metal continues to grow.

However, where gold travels the silver price usually follows. There was a wobble in the silver price last week before it continued the charge ahead on Friday. But with the Federal Reserve likely to taper its stimulus measures sooner rather than later, fundamentals such as industrial demand are unlikely to be the main driver.