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China Will Drive the
Price of Gold Up – But Not Just Yet

By Dominic Frisby

Chinese retail buyers could push the price of gold higher

It’s been quite a week for precious metals investors.

The big event to kick things off was the Swiss gold referendum on Sunday.

Goldbugs didn’t get the vote they had been looking for. But, strangely, things might be ending rather better for them than they thought.

The Most Surprising Thing
About the Swiss Gold Referendum

So, the Swiss gold referendum met with a resounding ‘no’. It was the expected outcome. But I must say I was a little surprised to see it fail by such a large margin – 77% to 23%.

The proposals – that the Swiss central bank hold 20% of its assets in gold at all times and be never allowed to sell – were just too uncompromising.

Those behind it were effectively demanding that the Swiss central bank buy the asset they like and own it in vast quantities and further protect their wealth by never selling. Not even banks or British landowners receive government favour on this scale.

I get the 20% ratio, but the never selling part of the demands was just too much.

Note for the future – if you are attempting to influence policy in some way via voters, suggest something that actually has a chance of getting through. Extreme ideas appeal to extremists, not to majorities.

However, what was so remarkable was the reaction of gold and silver to the news. They sold off, at first. That was the expectation.

Silver actually touched $14.20 per ounce during Asian trading, according to one data source. But then both metals turned and rallied. Short covering was so intense that by the end of Monday’s trading silver was at $16.75. That was an 18% move from low to high. I got one tweet from a happy trader who managed to catch the lion’s share of it – clever him.

Gold meanwhile rose by $75 from low to high. It was like the old days.

What we saw was a beautiful example of ‘sell the rumour, buy the news’. The market was expected to rally if the Swiss voted yes, and fall if they said no. But a no was already priced in. So – to the surprise of many – we got a rally.

What’s Next for Gold?

So what’s next? Well, yesterday I pottered along to Mines and Money, the UK’s largest mining conference, to debate the future of gold. There’s nothing like a mining conference to get you bullish about gold. They’re always full of bulls. Another note: beware mining conferences.

We were asked to give our outlooks for gold.

Mine is that the worst of gold’s bear market is over, of that I’m confident. This bear market is already the second-longest in gold’s history.

There is even a chance that Monday morning was actually the low. We might have seen what technicians call an ‘island reversal’. My target of 80 on the gold-silver ratio was as good as hit (we got to 78). So we look good for at least a bear market rally.

Much, of course, depends on what happens with the US dollar. Is its incredible rally over, or has it got further to go? My view is ‘probably the latter’.

It’s worth noting that gold is, on current form, the world’s second-best performing currency behind the US dollar. You wouldn’t know it – but of late sterling has fallen by more than gold. So life isn’t quite so bad for UK-based gold investors (as long as you’re not in miners). In fact, we’re actually up a few percent this year – not that it feels like it.

But – and I’m sorry to say this – I’m not convinced gold has made its final low.

There are still too many people – some of them at Mines and Money – trotting out the tired stories of yesterday.

Bringing some sense to proceedings were two gents of whom I think a great deal – Ross Norman of Sharps Pixley, and Ned Naylor-Leyland of Quilter Cheviot. I got into lengthy conversations with both afterwards and they had some interesting things to say.

Ned drew attention to the Chinese retail market. Around 100,000 bullion shops have opened there since gold buying was legalised in 2008. Something like 50 tonnes a week are being bought by the retail consumer.

If you extrapolate that over a year, you arrive at 2,600 tonnes – which is not far off annual global production (about 3,000 tonnes in 2013). In other words, the Chinese retail consumer is buying the equivalent of annual global production.

Some of that demand has been sated through the selling of Western exchange-traded gold. Transparent gold holdings are down by around 35% from the highs. It’s understood that as much as 1,000 tonnes of gold has made its way to Asia. Much of it has moved from London to Switzerland, where it was re-refined and melted into bar specifications for the Asian market.

Sooner or later Westerners will stop selling, and that physical demand will have to come from somewhere else. Eventually it will be reflected in the paper markets where the price of gold is actually determined. It will push the gold price higher. The question is when – and there’s your million dollar question.

The Worst of Gold’s Bear Market
May be Over But the
Bull Market has not Begun

I’m still sticking with my theory that the worst of the bear market may be over, but the new bull market has not yet begun.

Ross’s view was similar to mine. He sees a period of sideways action, before things get going again. Rallies are still being met with overwhelming selling. There is what he calls ‘investor fatigue’, and he sees many parallels between now and gold in the late 1990s.

We’re both of the view that gold needs a new narrative to get it going again – and this is something I plan to write about in a future Money Morning, perhaps next week.

There’s a massive opportunity coming in gold, silver and also oil, playing the rebound trade. Was Monday the low? Are you brave enough to dive in now? Or is gold going to $1,000, silver to $10 and oil to $50?

Get this one right and there’s a lot of money to be made.

If you want play this, I would advise you to make sure you have a definite risk strategy in place for the event that this isn’t the low.

Me? I’m going to stick with my cautious theory that even though the worst of the bear market may be over, the new bull market has not yet begun. Rather than bottom fish – which has been an expensive exercise through this bear market – I’m going to wait for a definite trend to emerge.

Editor’s Note: Dominic Frisby is MoneyWeek’s commentator on gold and commodities.

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