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A number of developments have surfaced in recent weeks that have boosted the appeal of gold. The most recent one comes out of China, where the government introduced policy changes that would encourage development of the country’s gold market. Some of these new measures would allow the four biggest state-controlled banks to trade gold bullion. As it currently stands, China is the world’s largest producer of gold and holds the number two spot behind India for consumption. These new measures would add more foreign members to the Shanghai Gold Exchange to foster greater liquidity while also permitting these banks to hedge gold positions. In short, greater development of China’s gold market provides a big future demand boost for gold.
It is also interesting that this development has occurred while U.S. growth prospects have been scrutinized and China has sought alternatives for its growing foreign exchange reserves. Recent chatter out of the US Federal Reserve Bank has opened the door for a new round of quantitative easing that would keep interest rates at extremely low levels. One such maneuver was highlighted in a Wall Street Journal article this week that suggested the Fed would use interest income from its portfolio of mortgage-backed securities to purchase additional securities or Treasury bonds. This threat has aroused further concerns over deflation and the monetization of debt. As a result of this fear, investors have been accumulating gold as a store of value.
Some cash traders noted a pick-up in the physical demand for gold as prices traded under $1200/ounce.
From a technical perspective, October gold is in the process of putting in an intermediate low. Prices established new contract highs in late June at $1267.10 and subsequently sold off to a late July low of $1157.50. That break also came with a drop in open interest that reduced some of the speculative participation in gold. This makes it ripe for a bullish turnaround. Interestingly, the July price low corresponds almost exactly with a 50% retracement of the February to July rally. Therefore, we see significant support at $1156.70 level, and as a result we believe the late July lows could prove to be a significant turning point for gold.
In addition, the market has penetrated the downtrend channel from the June highs, which also supports the idea that a low is in place. Traditional technical indicators were also oversold at this level as well.
On top of all of these positive forces, the market experienced all-time record high volume on the July 28th hook reversal lows, and this came in conjunction with a very small range. In other words, the market ran out of new sellers. We would expect gold to forge a rally back to the June highs at $1267.10 and potentially to another swing higher to $1306.70.
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