Precious metal prices have retreated again this week, with the price of the yellow metal now trading below USD $1180oz, down just over 1%. Silver is also down for the week, falling just over 2%, and currently sitting at USD $16.27.

It’s been a similar result for Australian dollar investors. Earlier in the week we saw the currency rally, as an RBA on hold and better than expected GDP results for the quarter seeing the AUD bid.

This was very short lived though, with disastrous retail sales and trade figures released Thursday confirming the negative outlook for the local economy, and again increasing the likelihood of further RBA rate cuts this year.

Other data out this week in Australia was lukewarm at best. Gross operating profit numbers for the quarter showed a 0.2% rise, but they were still down over 7$% for the year. Building permits, whilst still up 16% for the year, fell short of expectations.

AiG Group published their latest surveys looking at the outlook for companies in manufacturing, services and construction. Manufacturing recorded a pleasing rise, but it has come after five months of contraction, so it’s nothing to get too excited about just yet. Ditto for services, with the sector still in contraction, as it has been for much of the post GFC era.

This is troubling as services dominate the Australian economy, and especially as authorities are so desperate to see the economy rebalance from our reliance on mining.

The one silver lining in the services result was the explosion in the employment sub-component of the survey, which has been expanding for 6 months now, with last month signalling the fastest pace of expansion since May 2004.

This mornings construction survey was also disappointing, especially the readings for home and unit building, which have been the supposed bright spots of the Australian economy.

Back to gold, and the weakness in the last week has been frustrating for bulls, as it has come despite noted volatility in fixed income and equity markets, something ECB President Mario Draghi warned investors to expect going forward.

There has also been no USD strength evident either, which one would typically expect to see when gold is struggling. Indeed we’ve even seen the IMF publically ‘advise’ the Federal Reserve on monetary policy, suggesting the Fed should wait until 2016 before hiking rates.

We’d have expected to see gold receive stronger support in the face of these developments, and the lack of support this week does highlight the still weak tone for the market.

Increases in rates across the board and relatively soft physical demand out of Asia have no doubt contributed to the weakness, and there could be a few nervous short term longs who have decided to lighten positions heading into tonight’s non-farm payrolls report in the USA.

With that key release due to dominate market sentiment leading into what will be a relatively quiet week (retail sales notwithstanding) next week, it’s a good time to put together a quick technical outlook, for the USD, AUD and Gold.

Technical Outlook

If we take a look at the daily charts for Gold, the US Dollar and the Aussie dollar there are no glaring short term buy or sell signals, as most are awaiting to see if the US dollar can rebound and continue its rally higher.

Starting with US gold itself we can see there has been fairly low volume of late as we’ve been in a tight trading range since the start of April. There are no major oversold or overbought indicators as we wash sideways, but one thing to note is that the 50, 100 and 200 day moving averages remain in a bearish alignment. RSI and MACD could also decline, so overall we are looking fairly weak at the moment for US gold.

Now if we take a look at the US dollar you can see why there is a lot of uncertainty at the moment. Doubts are kicking in as to whether or not the Fed can normalise rates in any meaningful way without adding to volatility in financial markets and slowing an at best lukewarm economy.

If we were to look purely at what the charts are saying there is some overall weakness in the US dollar. The price has broken south of the 50 and 100 day moving averages of late, and the 50 day moving average looks like it could be rolling over. Too early to call though and it would not be surprising at all to see it rebound and push higher, especially if payrolls surprise to the upside (+250k minimum, with some wage growth as the icing on the cake for dollar bulls).

Finally, we come to the AUD. The story of late has been one of a falling/stagnant USD gold price, but a rising AUD dollar gold price.

We’ve seen this in many other countries over the past 18 months, as gold in Yen, Euro, rubles and the like has been very strong (the recent 20% spike in physical demand in countries like Germany is testament to this). As such, recent weakness in the gold price has been largely based on the USD rally which you can see so clearly on the chart above.

Back to the AUD and it is clear it is approaching key support. Predominantly weak data of late have weighed on the currency, with the 0.755-0.760 US cents level critical.

There will likely be a lot of stop losses below this level so if it breaks we should see some selling. MACD and RSI suggest further short term weakness is not out of the question, and a few more disappointing economic numbers, or hints from the RBA of a future rate cut should get us below this level.

If it does break below this level, targets well below 0.70 US cents are not out of the question before the end of this year, which will more than cushion any potential falls in USD gold prices.

Either way, investors are better of dollar cost averaging into the market today. For despite the short term weakness, fundamentals will win the day in the end, and be the key driver of the precious metals market. After all, as Benjamin Graham once said; “in the short run, the market is a voting machine but in the long run, it is a weighing machine.”

And when the market weighs up not just the historical overvaluation in financial assets, but also the economic risks we are still exposed too, and the difficulty that we will have resolving those one way or the other, we are certain it will put a higher value on the security of precious metal ownership.

Is China Oversupplied With Gold?

Earlier this week we were invited to talk to ABC’s “The Business” host Ticky Fullerton, where we discussed all the latest drivers in the gold market.

For those of you are keen to watch the video (shot in Custodian Vaults), you can access it here.

Amongst other things, we discussed the news that Austria would be repatriating national gold reserves from the United Kingdom, how changes to the RBA cash rate and the deteriorating outlook for the Australian economy would impact the AUD, and the news that China would be launching a 100 billion Yuan fund to stock pile bullion and promote gold ownership as part of its Silk Road Project.

One of the other things we were asked about was the potential ‘oversupply’ of gold in China, with ANZ bank last week stating that they were short term bearish on the metal, seeing a potential price drop toward USD $1,100oz.

Part of the reason for their caution towards the metal market is the relative softness in recent Chinese gold demand, with the World Gold Council’s Q1 2015 gold demand report suggesting that Chinese purchases (for jewellery, bar’s and coins) totalled just 275 tonnes, down 7% from a year earlier.

ANZ stated that; “The Chinese gold market looks to be in an oversupplied position once again. Total gold supply in Q1 15 exceeded demand by 150 tonnes after 200 tonnes were added in Q4 14. While some of the surplus is due to higher gold lending volumes (which will eventually be drawn down) and higher pipeline stocks, the softness in retail gold demand over the past few quarters is a little concerning.”

We don’t necessarily disagree with the short term caution that ANZ are displaying, and indeed if the non-farm payrolls report in the United States overnight comes in at over 250,000 jobs, then we could see gold fall below USD $1180oz quite comfortably, though the AUD will likely fall too, mitigating any price weakness for local investors.

We also aren’t entirely surprised with the recent slow-down in Chinese gold demand, as the economy there has cooled, and also as a result of the extraordinary rise in the Chinese stock market.

For an understanding of just how ‘sensational’ that rally has been, especially relative to gold since the year started, consider the chart below, which highlights the performance of both gold and the equity markets in China.

But whilst we agree with the potential for further short-term weakness in prices, and whilst we also aren’t hugely surprised to see a slow-down in the pace of Chinese gold accumulation, we don’t agree the gold market is oversupplied per-se.

Remember that when it comes to the Chinese people, physical gold is a highly sought after asset, treasured as both an ostentatious display of wealth, as well as a premier savings asset.

Consumption is also highly correlated to rising national incomes, as it is India.

Indeed if we look at Chinese jewellery demand (by far the most preferable form of bullion ownership in China to date) – we can see that it more than tripled from 200 tonnes per annum back in 2003 to 669 tonnes in 2013, a quite remarkable increase that attests to the fact that gold jewellery is one of it not the premiere ‘luxury’ goods that ever more affluent Chinese citizens will purchase.

That number is forecast to strengthen further, hitting 780 tonnes within 2 years, a 17% increase from 2013 levels.

On the private ‘investment’ side, bar and coin demand has risen by a factor of 40 in the decade to end 2013, hitting almost 400 tonnes by the end of 2013, according to WGC data.

This too is set to strengthen in the coming years, and a continuation of low to negative real interest rates will help propel higher gold demand in China, much as it will in parts of the developed world.

When it comes to the Chinese central bank, their holdings and buying intentions are, to use a term made famous by Donald Rumsfeld; “known unknowns”.

We all wish we knew the answer for how much they have, but no one can be certain.

But we do know the following

• As a percentage of foreign exchange reserves, China’s gold holdings are dangerously low, especially relative to other developed market nations

• As a percentage of GDP (probably a better metric to use), China’s gold holdings are also too low, again compared to other developed market nations

• President of the China Gold Association Song Xin has been on record stating the Chinese government should aim to build holdings toward 8,500 tonnes in total, so that their ownership more than matches that of reported US Gold Holdings

As they only admit to holding just over 1,000 tonnes right now (most intelligent estimates put the real number between 3,000-4,000 tonnes), it would suggest they’ve got quite a bit of buying to do in the coming years.

Now this doesn’t mean that they’re going to crash the US Dollar and send the gold price sky rocketing imminently. Indeed that would be against their own interests.

On that matter, we really enjoyed an article published this week in the Daily Reckoning Australia. Written by Jim Rickards, it was titled; “Why Most Pundits are Dead Wrong About China’s Gold”.

In it, Rickards was quick to point out that those who think the Chinese are soon going to turn their back on the USD, as well as global institutions like the IMF and the World Bank are likely to be sorely disappointed.

Indeed China is in no position to replace the USD with a fully gold backed yuan, . with the yuan is still only used for something like 2% of global payments, vs. some 40% for the USD.

And despite their development over the past decade, China still lacks a yuan denominated bond market of sufficient scale to attract funds from countries running trade surpluses.

Instead, according to Rickards, China is wanting to “do what the US has done, which is to remain on a paper currency standard…but make that currency important enough in world finance and trade to give China leverage over the behaviour of other countries. The best way to do that is to increase its voting power at the IMF and have the yuan included in the IMF basket for determining the value of the special drawing right (SDR).”

Rickards goes on to note that: “The rules of the game say you need a lot of gold to play, but you don’t recognise the gold or discuss it publicly. Above all, you do not treat gold as money, even though gold has always been money. The members of the club keep their gold handy just in case, but otherwise they publicly disparage it and pretend it has no role in the international monetary system. China will be expected to do the same. It’s important to note that China will not act in the best interests of gold investors; it will act in the best interests of China.”

As always, Rickards article is worth reading, and can be found here.

Whilst correctly pouring some cold water on some of the more excitable theories that about in the gold space, Rickards was also certain to stress the importance of owning physical gold, stating that; “Gold is still the safest asset, and every investor should have some in their portfolio. The price of gold will go significantly higher in the years ahead. But contrary to what you hear from the pundits and read in the blogs, gold won’t go higher because China is confronting the US or launching a gold-backed currency.

Bottom line: Temporary slowdowns in the year on year Chinese gold accumulation are not unexpected, and may impact prices, or sentiment toward the market in the short term. But they do not alter the primary trend for higher Chinese gold demand over the medium to long-term.

This demand, both pro-cyclical purchasing from the hundreds of millions of Chinese citizens entering the middle class, as well as strategic stock pile being built by the Peoples Bank of China will continue to provide a strong level of support for the physical gold market, one that was almost completely absent during the metals last secular bull run.

When (and it really is just a question of time) it combines with renewed developed market investor interest for the precious metal, it has the potential to cause a ‘perfect storm’, which will see gold (and silver) prices head significantly higher.

For Australian investors, who also have the opportunity to benefit from this investment via a falling dollar, the case for precious metal inclusion in a properly diversified portfolio grows more compelling by the day.

Until next week

Disclaimer

This publication is for education purposes only and should not be considered either general of personal advice. It does not consider any particular person’s investment objectives, financial situation or needs. Accordingly, no recommendation (expressed or implied) or other information contained in this report should be acted upon without the appropriateness of that information having regard to those factors. You should assess whether or not the information contained herein is appropriate to your individual financial circumstances and goals before making an investment decision, or seek the help the of a licensed financial adviser. Performance is historical, performance may vary, past performance is not necessarily indicative of future performance. Any prices, quotes or statistics included have been obtained from sources deemed to be reliable, but we do not guarantee their accuracy or completeness.