ANALYSIS – Has the rise in Asian gold demand put a floor below the price?

London 13/06/2013 – Gold priced in dollars fell off a cliff in mid-April, falling more than eight standard deviations, breaking through its previous floor at $1,522-27 per ounce and bottoming out at $1,325.

The metal was last around $1,390, still down around 17 percent on the year, having averaged gains of 25 percent in 12 straight years to 2011.

Still, investors in Asia saw the mid-April sell-off as a buying opportunity – they rushed to buy physical gold in the form of bars, coins and jewellery.

The drop below $1,500 unleashed pent-up physical demand across several Asian regions – Chinese investors bought more than 300 tonnes of the metal. This pushed up premiums and effectively placed a floor under the price, allowing a return to $1,488.

The return of physical demand when prices dropped confirmed that its subsequent rebound back towards $1,500 was not a ‘dead cat bounce’ but rather real investor demand.

The question is: can this floor, which is close to the price of production of around $1,200, be maintained or will physical demand also begin to waiver?

Several factors highlight continued demand from Asia while the price continues to consolidate below $1,400. Chinese premiums for physical metal jumped to $33 per ounce from mid-April from an average of $7.22 prior to the April sell-off, for example.

With foreign reserves of $1.5 trillion in a weakening currency and the potential for further inflation if the Chinese government decides on a secondary stimulus package, demand for the safe-haven metal has only been reinforced by the recent run of weak data from China, which has provided Chinese consumers with a further reason to own gold.

With Beijing approving two new exchange-traded products (ETPs) backed by physical gold, which will be traded on the Shanghai Stock Exchange, it will be now be even easier for Chinese investors to move money in and out of gold, widening the market beyond buyers of physical metal.

Deutsche Bank is opening a 200-tonne gold storage vault in Singapore to take advantage of the strong rise in demand from Asia.

Singapore’s decision to remove the sales tax liability from gold traded for investment purposes last year should further raise the appeal for investors looking to diversify part of their investment portfolios into the metal.

This is also likely to prove e a very popular option for safeguarding value, especially from other nearby countries that have undergone gold confiscation programmes in the past.

Elsewhere, demand for the yellow metal has been so strong in India that the government has cited it as a main cause of the country’s current account moving into a deficit – of $7.5 billion in April.

New Delhi has responded by increase the duty on gold imports twice – from four percent to six percent earlier this year and more recently to eight percent in a further attempt to curb enthusiasm for the precious metal.

Following the recent price decline, India’s gold imports reached 162 tonnes in May, almost twice the normal average despite the higher import tax. With the gold gifting season approaching, this theme is likely to be maintained.

And Japan has also unleashed an unlimited quantitative easing programme that will inject 50 trillion yen per year into the economy, roughly 10 percent of Japan’s annual GDP, with the express aim of weakening the currency dramatically to fight deflation. But this huge devaluing of the yen has driven domestic investors into the precious metals as a hedge against inflation.

With all of these bullish factors likely to be maintained while the global economy remains in troubled waters and the production cost so close below the current price, we would expect any further drops in price to be cushioned and quickly absorbed by increases in physical demand across several Asian markets.

Although we do not foresee a break below the current floor to below the production cost, we would expect any such move to be short-lived – investors will be wary of being caught on the wrong side of the equation.

We would therefore expect the floor below prices to remain intact, making the potential downside from the current price action at around $1,450 minimal compared with the potential upside, a factor that we believe many in Asia are banking on.

(Editing by Mark Shaw)