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Gold – Central Bank’s & QE is the Game Changer

August 8, 2015

One must be wondering that why gold was a better buy on dip about 4-years ago and why it is now a risk to buy despite 43 pct fall from all time high of $ 1913 (August 2011).  Lower purchase of gold by the Global Central Bank and withdrawal of US Quantitative Easing (QE) is the real game changer.

Geo political condition, Global economic slowdown and debt crisis in the Euro zone region were also some of the causes that saw investors interest in gold. Investors are prone to uncertainty and in such a situation they rush to buy gold as investments considering it as a safe heaven.

But the sharp rise in price of gold was caused in haste due to Central Bank’s constant buying of gold, as part of portfolio to increase its proportion of Reserves due to currency risk.

For several years, printing of money by Federal Reserves to stimulate its ailing economy weakened US Dollar, which was also driving gold prices higher. The era of money printing (QE 1, QE 2 and QE 3) by FED lasted for nearly 5-years that were helped by near zero-interest rate policy.

Similar to US Quantitative easing strategy, European Central Bank and Bank of England followed FED’s footstep, probably fearing more financial disorder in its region. After difficult 5-years and various types of experiments, US economy is showing signs of growth and is now in a recovery path.

Despite opting for quantitative easing strategy, European economy is still struggling to grow at required pace and could not counter higher unemployment rate, which is still alarmingly high rate. This is surely due to improper allocation of funds, which did not go towards corporate spending and instead assigned to fix weak balance sheets and meet debt requirements.

The main driving force behind gold’s one-sided up-move was helped by speculative factors, as investors/hedge funds firmly believed that unwinding would never be easy. The difference between US QE and European QE is that US QE money was freely flowing towards commodity market, as banks were the direct borrowers.

Whereas, European QE money has many hurdles before it is being credited. Unlike FED, ECB has a Governing Council Members that has 6-decission making members of the Executive Board plus Central Bank Governors of 19-Euro area counties that makes sure that QE does not go into wrong hands.

Therefore, after US taper announcement, the shift in gold trend clearly became visible. Threats of Euro zones break-up and risk to European currency (EURO) have faded, as Grexit may larger impact as earlier estimated.

China’s financial problem is constantly deteriorating due to weak controls and is surely beyond its stock market. Recent reports suggest that Chinese regulators in past 2-months have injected Yuan 900 billion ($ 147) to prevent meltdown. While, Chinese investors have already pocketed excess gold at very higher levels and may want to refrain from fresh buying when trend is still on the downside except for some occasional correction that may occur.

Whereas, Central Banks past buying of gold is a myth, as majority of them were the followers. I have my doubts about the genuineness of past strength of gold that we saw in last 5-years. Central Banks of advanced economies, holding large quantity of gold probably preferred stronger gold to support their balance sheets, which was taking hit on its EURO holdings due to Euro-zones crisis and uncertainty.

To assess the market sentiment, out of the total Global Central Bank’s Reserves holdings of USD 11.40 Trillion as of June 2015, Euro’s currency composition of its official Fx Reserves has fallen down down to around 22 pct ( USD 2.5 Trillion current ) from the highs of 28 pct in 2009 or ($ 2.1Trillion past). In 2009 total size of Global Reserves was USD 7.5 Trillion.

This means, since 2009 purchase of EURO by Global Central Banks increased by mere USD 400 Billion, despite rise in CB’s holding by USD 3.9 Trillion during this period, suggesting confidence in the strength of US Dollar.

Therefore, gold does not have enough reasons to laugh and should find buyers on corrective recovery. Trouble in Iran deal or Middle Eastern tension could see some small uptick, but sellers will be determined to cash the opportunity.

Gold is holding above $ 1040-60 levels for a while, which means there is a small risk for minor correction and if holds, a test and break of $ 1120-30 zones is required for a another 30-50 USD gains. But sellers would continue to dominate. Hence profit taking is suggested, as protection will remain around $ 1180-00 levels for my yearly target and test of USD 925-50 zones. Only upside break would risk for USD 1250-80 levels.

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