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Gold 'bullish' stars all-round.

Summary: Max Knudsen, Chief Market Strategist at ADS Securities reviews the reasons behind summer market calls that have underpinned the sentiment for gold

In July's edition of BME we identified early signs that the year's bearish view of gold was changing, and recommended buying a gold option to benefit from a more positive outlook. The good news is that gold prices did rally through July and August by $170. If you took a 'One Touch' $1450.00 gold option paying out $50,000, if gold reached $1450 an ounce within three months, then you did very well. The cost of buying this option was a once only payment of $9,750. On 28 August, with gold near the $1437 target, the option was selling at $38,000, an increase of 389 per cent. So we hope that your view of the market was the same as ours.

Whether market calls are right or wrong, it is always important to review them and understand what underpinned the change in sentiment and what we can learn from this going forward.

At the end of June there was a lot of negative noise about the drop in the price of gold, which was heralded in the media as 'The biggest price fall in gold in 90 years'. The hedge fund community cut its expectations of higher prices by 80 per cent and the market was predominately short with analysts talking of gold heading to $1000. However, the start of July saw the market record three days of gains for the first time in two months. This was an early sign that investors' willingness to sell gold was becoming exhausted, and raised the potential of profit-taking buying.

By the second week of July and with prices at $1285, the slow down had formed a Bullish Star signal, a pattern of trading highly consistent with exhausted bearish sentiment and the start of a new positive bias. The pattern reflects a market experiencing a change from buying to take profits on previous bearish trades, to buying to open new bullish positions. The trading history across FX, bond, equity, and commodity markets is littered with examples of major turning points in sentiment first identified by these star signals.

The early recovery signs also reflected strong physical buying interest at lower levels. Premiums on Chinese gold stayed high and total US Comex registered gold stocks fell to a 12 year low of less than one million ounces, underlying the tightness of the physical bullion market. Physical buying had never really gone away but the market needed the return of speculative buyers to really make the difference.

In August, the speculative buyers of gold did return in large numbers, with momentum boosted by a pick-up in the Chinese economy, the world's second biggest consumer of the metal. Bullion on the Shanghai exchange was at one stage $26 more expensive than London. Premiums for gold bars in India, the biggest consumer of the metal, rose to $45 an ounce, up from $25 just a week earlier. Consumer demand in India, the biggest buyer, jumped 71 per cent in the second quarter and in China, it gained 87 per cent, helping to push global bar and coin purchases to a record and jewellery usage to the highest level since 2008. There were signs of rising demand elsewhere. Turkey's bullion imports through July were 80 per cent higher than in all of 2012.

The improved optimism and physical demand came at a time when holdings of gold in exchange traded products had dropped to a three year low and speculators held record numbers of bearish trades. Add in the risk of military conflict in Syria and the justification for the flight to gold was complete. With reasons now to re-enter the market, and rising prices forcing sellers to close out their losing bearish trades, gold surged. On 28 August it reached within $4 of our key target for the rally. From those first early signs of change in gold's trading pattern at the start of July, followed by the star signal, our analysis showed the most probable outcome for an improvement in sentiment would be for gold to recover half of all this year's $516 losses. That would take it to $1437 an ounce and when this level was reached we expected significant profit taking. This has occurred. Since trading to $1433 on 28 August, 2013, gold has indeed reached a temporary ceiling.

So where do we go from here? Gold is now $60 lower than the recent high at the end of August, and for now the potential is for still lower prices as the market unwinds some of the two months gains, potentially as far as $1300. We are expecting to see further volatility when the current bearish sentiment is exhausted and will, of course, let you know of any further investment or selling opportunities.

The pattern reflects a market experiencing a change from buying to take profits on previous bearish trades, to buying to open new bullish positions

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Publication:Banker Middle East
Date:Sep 23, 2013
Words:853
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