Gold still in bullish mode

TEXT: An eleven percent surge in gold prices in June is the biggest monthly gain in eight years. After hitting a record all-time high in futures trade, touching $ 2000, spot price is a whisker below, but has tested the highs.

The market is unsure whether or not gains will be further extended. It is extremely overbought, but gold is still in a bullish mode and its fate will depend on quite a few factors.

PAKISTAN HOLDS 2.078MLN TROY OUNCES

Since gold is shown on the SBP website as its official asset and as of June 30, 2020, gold holding is 2.078 million fine troy ounces or 71.25 tons, valued at $ 3.674 billion @ $ 1768.26, which is 21.63% of the official reserve asset.

Unfortunately, Pakistan's gold holdings cannot be swapped, as they do not custodianship of either the Bank for International Settlements (BIS) or the Bank of England (BoE) in the shape of physical bars. Gold had to be under the custodianship abroad in accordance with London Good Delivery (LGD) standard. Bar size traded on the London bullion market is approximately of 12.5 kg or 400 oz and minimum gold purity is 99.5%. The gold in possession of SBP is, however, mostly confiscated; it is impure and is mostly in a non- standard physical form.

It is important to note that in the past SBP did not buy this commodity for its reserves portfolio. SBP does not allow import or export of gold. There are instances of SBP approvals to gold transactions being done through the open market; but it took such decisions only in rare or extraordinary circumstances.

GOLD ANALYSIS

Global central banks currently possess nearly 35,000 tonnes of gold reserves valued at roughly $ 2.43 trillion or 20.7% of global forex reserves. As per the International Monetary Fund ( IMF) data, the size or composition of Foreign Exchange Reserves (COFER) Q1 2020 is USD 11.732 trillion.

One thing is for sure that if we take a look at the composition of Foreign Exchange Reserves portfolio of global Central Banks (CBs) of the last 12 years, gold has extraordinary CB support.

They have started adding gold to their portfolios after the 2008 financial crisis and have been snapping the metal aggressively as a hedge against currencies. CBs' annual purchases that averaged around 120 tonnes before the crisis, shot up beyond 400 tonnes in 2012 to over 600 tonnes in the next two years.

Until 2009, 7 to 9 advanced nations were already holding nearly 20,000 tonnes of gold with the remaining countries holding nearly 7,200 tonnes of this precious metal. This means in the last 12 years, more than 7,000 tonnes of gold was added to global CBs' kitty. Major buyers are Russia, China, South Korea, Kazakhstan, Turkey, India and a few others.

Purchase of gold and building of its portfolio by the global CBs are a diversion in its policy to minimize the risk of currency exposure that simultaneously allow hedging of its asset. Developing economies that have enjoyed trade surpluses have adjusted their stance accordingly.

GLOBAL INTEREST RATE & QE

The economic activity will surely not pick up as the pandemic is likely to stay for next 18 to 24 months. Coronavirus has brought the global economy to near standstill and has choked cash flows, forcing governments and CBs to provide exceptional fiscal and monetary support.

Hence, Central Banks around the globe chose to go for aggressive rate cuts and injected a record amount of cash through quantitative easing.

After the 2008-9 Europe and the US Subprime meltdown, liquidity of more than USD 3 trillion was injected through bond buying along with more than USD 500 billion, special Central Bank Liquidity Swap facility through bilateral arrangements.

In the 2008 crisis, only a tiny amount of QE money flowed into the real economic sector.

This is why Quantitative Easing (QE) is only a temporary arrangement. It will last until it is not needed. Unless a good part of money created through bank lending does not enter the real economy or the corporate sector, the desired level of stable growth will never happen. Asset purchases only help in expanding the balance sheets of Central Banks.

The problem with QE money is that CBs purchase financial assets and the money gets deposited in the bank accounts of sellers. Large amounts of money rotate and the newly-created money again goes into the financial market that ultimately gives a boost to commodities, including gold, stocks and bonds.

Last but not least, the US FED has given a clear signal that interest rates will remain low for a long period of time hinting that its outlook for the US economy remains on the downside.

The key to watch is that if US interest rates go down below zero in the near term. A liquidity injection of trillions of dollars could give a further boost to the yellow metal. Before all this happens, gold could still surpass $ 2000 level and stay above for a while and then may ease.

To test $ 2300-2500 zones in near to medium term, further FED easing and a big liquidity injection are required. Further pandemic spread could see a rush for gold.

Any central bank buying will definitely push gold towards $ 2450-00 zones with comfort. However, on the downside, gold is unlikely to see $ 1400 levels in the next couple of years. Buying on dips will be a preferred strategy.

In the short term, there is a risk for gold correction. Gold could sharply decline by $ 150-200 on any minor factor, as technically it is extremely overbought on the Relative Strength Index (RSI).

In the medium term, risk sentiment will also depend on November US elections, Gold surge will also depend on President Trump's victory or else it could slump for a correction.

It has support at $ 1880, break risks for a test of $ 1820, with a major support zone around $ 1720-60 that may not surrender in the short term or else $ 1580.

However, on the upside, a break of $ 2080 level is required to test $ 2180-00 or about and the rally could exhaust for correction if it fails to break.

Next major resistance is around $ 2350-80 zones, which appears to be the next target for gold.

(The writer is former Country Treasurer of Chase Manhattan Bank)

Copyright Business Recorder, 2020