Gold, Debt Ceiling & Missiles

<p>Gold is quickly catching up in erasing the damage from late spring-early summer as it completes 2 consecutive monthly rises and is the 2nd best […]</p>

Gold is quickly catching up in erasing the damage from late spring-early summer as it completes 2 consecutive monthly rises and is the 2nd best performing commodity so far this quarter, up 14%  (after silver’s 20%).

The bearish case in gold has grown less straight forward than it was three months ago when US inflation drifted near 40-year lows and US-10-year yields drifted near 2.00%. Much has changed since then. The notion of Fed tapering is no longer regarded as a necessary threat to gold bulls and US dollar bears after the Fed has emphasized it will maintain accommodation for as long as it takes; and insisting rates aren’t rising before end of 2014.

Rising yields are generally considered a negative for gold as they render investors an implicit rate of return, which is lacked by gold. If on the other hand, yields are propped by inflationary expectations then the case for the yellow metal gold sets in. But we are farm from those days. Not only interest rates remain near 40-year lows, but there is no certainty that the Federal Reserve will not be forced to step up asset purchases 6 months from now.

Recovering demand from China also helped. Chinese imports jumped 10.9% in July vs 5.1% for exports, indicating rising domestic demand recovery, which augurs well for Chinese gold demand. The case for buying gold from Indian and Chinese households simply as a result of sharp declines cannot be ignored as the power of retail investing continues to carry weight.

On the speculative side, traders’ commitment reports from the Comex showed net longs fell to an 8-year low of 16,557 contracts in July, a 90% decline from the net long positioning in October when gold stood near $1800.  Today, net long gold activity is up more than 260%, reaching 60,396 contracts, but still well below the 200,000 highs from last autumn when gold rallied on the hysteria of the ECB’s OMT program and fiscal cliff concerns in the US.

The bullish case for gold holds that mine closures resulting from falling exploration projects will take prices higher. Other gold bulls don’t believe the economy is on the mend, nor expect the Fed to make any meaningful reduction in asset purchases. If anything, they believe the Fed will be forced to step up asset purchases in H2 2014 after failed attempts to tighten monetary policy.

Debt Ceilings & Missiles

This week’s reminder from US Treasury Secretary Lew that US govt borrowing will hit its limit in mid-October should further rally gold bugs as it not only sets the stage for another round of budgetary brinkmanship but also limit the Fed from scaling down its stimulus. As the governmentt is faced with a new round of spending cuts to replace the sequester, markets will expect the central bank to be more cautious and even extending asset purchases while tapering them at a slow pace.

On the Syria front, as long as the US, UK and France resume their bellicose rhetoric with regards to striking Syria, the risk premium in gold and oil remains. Besides the uncertainties factor related to the details of a possible strike, the most dangerous unknown remains that of the Iran’s role in reacting via its militia forces in Syria and Lebanon. The multi-scattered Assad regime is unlikely to be eroded with a single attack. A strike would deepen the quagmire in Syria and risks introduce the Israel-Iran response into the MidEast equation. All of these factors will further boost uncertainty and provide broad support for gold.

The rally in gold has clearly accumulated an additional factor besides monetary policy considerations. Gold is seen targeting the top of its 10-month trendline, nearing $1480 as long as $1360 is held. Further upside shall depend on the outlook for growth vs disinflation. Considering the seasonality of gold’s performance in September over the past 10 years, the upside is intact for now.

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