Will Chinese Investors Rotate To Gold?

Strengths

• Gold traders are the most bullish in a month on the prospect of slower U.S. interest rate increases. Gold saw a second weekly advance after efforts to secure a Greek bailout faltered and the Federal Reserve signaled a more dovish stance on interest rate increases. Shanghai Gold Exchange withdrawal volume in the week to June 12 came in at a strong 46.2 metric tonnes.
• The Bank of China will become the first Chinese bank to join the auction process that sets gold prices in the London market. The bank, along with seven other lenders, will start participating in the twice-daily electronic auction. The addition of a Chinese bank is another sign that China is increasing its influence in gold and currency markets worldwide.
• Cornerstone Macro’s survey shows that neutral investor sentiment is at a 25-year high, with both bears and bulls disappearing. Such ambiguity could quickly translate to panic given a rise in volatility in the markets.   
• The gold monetization scheme in India aims to unlock the value of jewelry sitting idle. However, the current plan may not be enough to lure people to park their gold in a scheme that offers one gram for every 100 in a year. Furthermore, it may prove difficult to overcome people’s sentimental attachment to their jewelry assets placed on deposit as they will be melted for only a 1-percent return.

Weaknesses

• Morgan Stanley sees gold prices under pressure for the rest of the year given expectations for an increase in U.S. interest rates along with subdued retail demand. They also mention the rapidly strengthening equity markets in China drawing investors away from gold as well as the heavy rains in India putting a dampener on Indian demand.
• The managing director for the Far East region at the World Gold Council said that a gold upheaval is unlikely when the U.S. raises interest rates. Instead, higher rates may create adjustments in the gold market. Additionally, Kitco Metals noted sales are down 13 percent from this time last year. Silver sales are down 17 percent.
• According to Metals Focus, silver prices will likely average in the high $15-per-ounce level during the summer but rise to the $16 level in the fall. Average prices in 2015 are likely to be about 15 percent lower than last year, but rise about 10 percent in 2016 as the uncertainty over interest rates fades with the expected gradual increase in U.S. rates. Weakness in platinum is apparent with prices slumping to a six-year low.

Opportunities

• China continues to be one of the world’s largest buyers of gold as shown by the increased offtake of physical deliveries from the Shanghai Gold Exchange as the country is working towards establishing the renminbi as a reserve currency.  Another factor that could drive gold higher could be a rotation of funds within the country.

• Policymakers squelched the run in the Chinese real estate market, pushing billions of dollars into the country’s stock market. If Chinese investors suddenly sour on stocks, their next move could be to gold. Furthermore, Paradigm Capital published a study looking at what the next gold upcycle might look like. Taking into consideration the past five upcycles, they determine there is an 80-percent probability that gold will average over $1,540 per ounce, and could move much higher than $1,940 over the next three to four years.

• Low interest rates, private equity and some miners flush with cash while others are in need of major debt reduction, may cause a sharp increase in precious metals mergers and acquisitions (M&As) this year. Bloomberg shows that deals for gold mines reached a two-year high in the second quarter and the premium paid for public gold companies soared, and was the second highest over the past 12 years. This bodes well for further consolidation in the industry and highlights how cheap current valuations are.
• Klondex Mines reported that the Water Pollution Control Permit for its Fire Creek project is in hand, and the tonnage cap linked to Fire Creek’s operations is now lifted. Upcoming catalysts include resource updates for Fire Creek and Midas incorporating positive drill results released this year, the Midas TSF expansion permit to increase tailing storage capacity, a potential U.S. listing and inclusion in major gold equity indices, and the Fire Creek Environmental Assessment approval.

Threats

• A record number of investors told Bank of America Merrill Lynch this month that they have taken out protection against falling stocks over the next three months. According to Alan Ruskin from Deutsche Bank, 2015 will go down as the year when major central banks hit an inflection point in their willingness to distort and manipulate markets. Thus, the mix of overt and subtle withdrawal of market support is a key macro driver of recent market volatility.
• Apparently regulators care much more about manipulation of the stock market than gold. This is because the sentence handed down to Mirus Futures for allegedly spoofing the gold futures market in February 2014 was only $200,000, while Nav Sarao, the kid who allegedly spoofed the S&P 500 Index in 2010, could spend up to 380 years in jail.
• According to the latest plans for a gold monetization scheme in India, sovereign gold bonds will provide a good alternative for investors, and if subscribed fully in the first year, it will result in a saving of $2 billion on imports of bullion at current prices. This would represent 27 percent of the 2014 investment demand. The rate of interest will be linked to the international rate for gold borrowing, but with 2 percent as the indicative lower limit and interest rates will be paid in terms of grams of gold.

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