This is getting ridiculous. And that’s a good thing. By “this,” I mean the price of gold, and by “ridiculous,” I mean repetitive to the point of absurdity. That’s OK. The prospects for gold from here are highly positive.
By now, readers are tired of my description of gold trading as range-bound between $1,700 per ounce on the low side and $1,900 per ounce on the high side, with $1,800 per ounce as the central tendency. That’s completely accurate but also highly repetitive, since it has held true with only brief and minor exceptions for the past year.
This pattern emerged in November 2020 after gold fell from its all-time high of $2,069 per ounce on Aug. 6, 2020. The predictable question from investors is: “Fine, we get it. But, when does the pattern break either to the upside or downside? What’s next for gold?”
That’s where the good news begins. Yes, gold has been range-bound, but the range is getting smaller. While swings of 5% in a matter of days were common as recently as last summer, that volatility has cooled off. Gold still moves up and down in price, but the swings are much more compact.
The central tendency is still $1,800 per ounce, but the swings are more tightly bunched between $1,750 and $1,850 (again, with a few exceptions). That’s a 5.5% band to replace the prior 11.0% band.
We’re also seeing a pattern of lower highs and higher lows as compression continues. That’s a technical pattern called a pennant because it looks like a sports pennant if you draw converging lines through the highs and lows.
A pennant is a setup for a breakout. The breakout can occur in either direction, but it’s more common for the breakout to continue the trend that existed before the consolidation.
Whether we take the $1,685 price on March 30, 2021, the $1,725 price on Aug. 9, 2021, or the $1,722 price on Sept. 29, 2021, it’s clear that this pennant formed in the wake of an uptrend. This suggests that the breakout will be to the upside and it will occur soon.
There’s a run of fundamental data that supports this technical view. The first piece of evidence is that the real price of physical bullion today is not $1,864 per ounce (according to the COMEX gold futures contract price), but closer to $2,000 per ounce according to my gold bullion dealer sources.
The difference between the two prices is about 8%.
The problem with this pricing method is that a normal dealer commission is around 2.5%. Any commission higher than that is not really a commission. It’s a reflection of scarcity, delivery delays and other logistical issues in getting actual physical bullion instead of paper gold contracts.
In other words, $1,925 per ounce is the real price of real physical bullion. Everything else is just paper.
The second fundamental factor is that Russia is back in the game. As readers know, Russia has increased its gold reserves by 1,700 metric tonnes since 2009. Gold reserves were 600 metric tonnes in 2009 and are 2,298.5 metric tonnes today, a 283% increase in the past twelve years.
The Central Bank of Russia has pursued this acquisition plan in a steady and incremental way under President Putin and Central Bank Chief Elvira Nabiullina. Acquisitions of gold were regular in amounts of about 5 to 30 metric tonnes per month like clockwork to avoid disrupting the market.
In April of last year, the clock stopped. Russia reduced its holdings slightly in April, July, August, September and October 2020 and January and April 2021. Holdings were unchanged in November and December 2020 and February, March, May and June of 2021.
Now, Russia is back on the buy side. It purchased 3.1 metric tonnes in July 2021 and another 3.1 metric tonnes in September 2021 (August was unchanged). Analysts should not mistake this renewed purchasing as a buying binge by Russia. It’s something more subtle.
Russia is running the world’s most sophisticated hedging operation inside its global reserve account of hard currencies and gold. The object is to maintain gold at about 20% of total reserves. This goal was achieved in early 2020, which accounts for the fact that purchases tailed off after that.
Russia’s reserves are now bulging because of the steeply higher price of oil. This increases Russia’s dollar reserves since oil is priced in dollars. If dollar reserves are increasing and Russia wants to maintain gold at 20% of total reserves, it has to buy more gold to maintain the allocation. This is no different than what everyday investors do when they rebalance target portfolios to account for large gains or losses in a particular asset class.
It’s also consistent with Russia’s hedging objectives. If the dollar retains its value, gold may not move much in price. Still, the allocation of gold in the portfolio acts as insurance. If the dollar crashes in value, the dollar price of gold will soar and Russia’s losses on its dollar portfolio will be offset by gains on its gold portfolio.
In its current form, the dollar is losing value, at least in relation to oil. The dollar price of gold has not moved much. So, that’s an opportune time to buy gold to maintain the hedge without paying a premium. The Russians are masters of this kind of dynamic hedging (unlike Americans). They just proved it again through the combination of expensive oil (generating revenue) and steady gold prices (offering an attractive entry point at which to maintain the hedge).
But Russia’s not alone. Other major central banks that have added materially to their gold reserves in recent months are Thailand (90.20 metric tonnes), Brazil (53.75 metric tonnes), Turkey (8.67 metric tonnes), India (8.4 metric tonnes) and Qatar (3.12 metric tonnes). Some central banks were net sellers, but the total sales of the top five were less than 25 metric tonnes, far smaller than the total additions.
And of course, China has acquired massive amounts of gold in recent years, which has been part of a concerted overall strategy. And recently, Chinese gold imports from Hong Kong hit a five-month high, up nearly 60% in September.
These central bank purchases were in anticipation of a declining dollar and higher dollar inflation. The central banks are buying gold to stay ahead of the curve. Shouldn’t you do the same?
for The Daily Reckoning