Strong Physical Demand to Underpin Volatile Gold Prices

JOHANNESBURG – Last week after hitting the lowest level in four months, the price of gold suddenly bounced. On Friday, news about the deteriorating situation in Egypt gave the gold price a big boost and traders who had been short, or sold, on gold’s recent pullback were suddenly covering their short positions or going long. At one time the price of gold surged by almost $40 an ounce. Personally, I do not see why the unrest in Egypt should be worth $40, but when it comes to predicting the gold price it has always been difficult to calculate the price move as determined by some geo-political crisis. In the past few months we have seen unrest in Greece, France, Tunisia and Yemen. And, only few months ago, tensions between the two Koreas had suddenly jumped to an all-time high. Yet, these events did not have the same impact on the gold price as the current situation in Egypt. It goes to show how traders react on news events and how their perspective on these events can impact on the gold market. This is one of the reasons why gold prices can be so volatile at times. Yet, the underlying fundamentals in the gold market have not changed and continue to provide an extremely bullish scenario for the yellow metal. 

Recently, there was news about how a tiny hedge fund SHK Asset Management run by, Daniel Shak, has been responsible for some of the recent price action seen in gold prices. Evidently, as gold prices started falling this year, the trade, which was a combination of being long and short gold contracts started going bad. And, on Monday, January 24, he liquidated his position and is returning money to clients. As a result, the number of gold contracts on CME Group Inc.’s Comex division plunged more than 81,000, to about 500,000, the biggest single reduction ever. While his trade didn’t account for all of the contracts, it accounted for a large percent of the daily turnover which on a normal day is about 3,000 to 5,000 contracts.

This goes to show you how one person can control one of the largest positions in the gold market. In an interview Shak said he quit the trade when he was 70% down. People close to the firm confirmed the loss was about $7 million.

While the futures markets can determine price action in the short-term, in the longer-term the simple supply and demand dynamics of the market will prevail. And, when it comes to gold, demand for the yellow metal has been very strong.

According the World Gold Council (WGC), investor demand for gold was very robust during 2010. The gold-backed ETF’s that the WGC monitors saw net inflows of 361 tons during 2010, the second largest on record after the 617 tons of net inflows experienced during 2009. This brought total holdings to a new high of 2167.4 tons by the end of December 2010 worth USD 98 billion at the year-end gold price.

Investment demand for gold bars and coins also continued to grow during 2010. Physical delivery at the Shanghai Gold Exchange totalled 836.7 tons in 2010. According the WGC report, physical delivery as a percentage of trading volume had increased to 33% by the fourth quarter as Chinese investors sought to get hold of gold bullion.

Demand for physical gold in other parts of Asia also remained very robust. The demand for gold in Taiwan increased in 2010, and in Vietnam, retail investment demand remained very strong. In India, initial reports tend to indicate that sales of gold bars were strong during 2010, in particular in the fourth quarter. And, due to the increase of demand, the Reserve Bank of India authorised seven more banks to import bullion.

Private investor demand for bars and coins in Europe and North America also continued to grow during 2010.  European and American investors led the way in gold bar and coin buying as a way to protect their wealth against currency devaluation, and as a hedge against inflation. In the US investors bought 1.2 million ounces (38.0 tons) worth of American Eagle bullion coins according to the US mint.

In addition to the increased investor demand, global jewellery demand totalled 1,468.2 tons during the first nine months of 2010, an increase of 18% from the same period during 2009. While the final data for Q4 will be released in mid-February 2011, it is widely expected that gold consumption for jewellery in 2010 will show an increase over the previous year. At the country level India, the largest consumer of physical gold, has shown signs of a recovery in demand for the yellow metal compared with the year before. During the first nine months of 2010, gold jewellery consumption in India rose 513.5 tons, 73% higher than the same period during 2009. Similarly, gold jewellery demand in Hong Kong, Russia, mainland China, and Saudi Arabia rose by 27%, 19%, 8% and 2% respectively during the first three quarters of 2010 when compared with same period in 2009. On the other hand, gold jewellery demand in the UAE, Japan, Vietnam and Turkey was slightly lower in the first nine months of 2010, relative to 2009 while the rest of the world saw a more significant contraction in jewellery consumption, in particular Europe. 

While the demand for physical gold remains robust and will underpin the price of the yellow metal the global currency crisis is only going to deteriorate. And, as our world continues to be influenced by lying politicians, corrupt bankers, deceptive investment advisors, national government debt that is spiralling out of control, not to mention budget deficits that are already out of control, governments will continue with their expansionary monetary policies. The end result will be further currency debasement, which in turn will inflate the prices of many commodities which will cause further unrest and thus merely perpetuate the cycle of unrest, inflation, currency debasement, currency wars, trade barriers and poor economic growth.


While the candlestick pattern is not a reversal pattern of sorts, the downward trend seems to be stalling and may well find support around the $1325 level. However, traders may try to push the price down to the psychologically important level of $1300. I believe that prices will trade with an upward bias in the short-term.

About the author

David Levenstein began trading silver through the LME in 1980, over the years he has dealt with gold, silver, platinum and palladium. He has traded and invested in bullion, bullion coins, mining shares, exchange traded funds, as well as futures for his personal account as well as for clients:

Information contained herein has been obtained from sources believed to be reliable, but there is no guarantee as to completeness or accuracy. Any opinions expressed herein are statements of our judgment as of this date and are subject to change without notice.

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