Asian Demand Should Stabilize Precious Metals

NEW YORK (TheStreet) -- Since the beginning of July, we have seen a steady push higher in gold prices and one of the central market questions at this stage is whether or not these moves mark a short term correction in the latest downtrend or a true reversal that can be supported with fundamental arguments.

At the very least, we can say that there is a number of opposing factors that should be taken into consideration, and that the backdrop is not entirely negative. But valuations in the SPDR S&P 500 Trust ETF ( SPY) are still lower by nearly 16% even with these latest rallies, so the broader picture shows that there is still a lot of ground to make up before we can say that the bear run seen in the early parts of the year has been overcome.

A series of long liquidations from several large investors (for example George Soros and John Paulson) helped to fuel the bearish downturns that marked the early parts of the year. From a macro perspective, expected policy changes from the Federal Reserve have also weighed, as any reductions in quantitative easing stimulus will likely set the U.S. dollar on a course for long term strength -- not only against its major currency counterparts but against the commodities space as well.

In addition to this, it should be remembered that gold is inversely correlated to stock markets and we are still holding within striking distance of the all-time highs in the S&P 500. And since the latest earnings season largely surpassed expectations (and price-to-earnings valuations still look attractive on an historical basis) there's little reason to believe that these trends will end any time soon. For these reasons, the safe haven allure of gold is unlikely to be a central driver for new bull trends in coming months.

Buying Surge in Asia

But at the same time, the fundamental backdrop is not entirely bearish for gold and this year's declining moves have been interpreted as a buying opportunity by many. Demand for physical assets in Asia has soared, relative to the purchases made during the same periods last year. Indonesia is one of the newest examples, as an unwieldy inflation situation has prompted widespread hedge buying in precious metals. Consumer prices in Indonesia are growing at a rate of 8.6% (the highest level in four years) but the country's central bank is reluctant to raise interest rates as this could negatively influence an already-weakening growth picture. For 2013, Indonesian gold consumption is expected to rise by 30% on a yearly basis, to 40 metric tons.

The bigger players, however, are China and India -- but similar trends are taking place there as well. For 2013, demand in these two countries (the world's largest gold markets) is expected to approach the 1,000 tons mark. In the first two quarters, gold buying in China came in at 571 tons, which is an increase of 45% relative to the same period last year. India assumes the second place position here, with gold purchases seen at 568 tons (a yearly increase of 48%.)

This buying came as investors looked for bargains, but the lower prices seen in the early parts of the year created supply constraints as well. Gold's foray below $1,250 per ounce made production unsustainable for large sections of the market and forced closures or output reductions in several key areas of production. As the resulting lack of supply filters its way into the market, additional bullish price scenarios are likely to emerge. So, while we continue to see reasons to avoid long exposure in gold, it is important to remember that the picture is not completely bearish -- and the balance between the negatives and positives should lead to more stabilized price activity in coming months.

At the time of publication the author held no positions in any of the stocks mentioned.

This article is commentary by an independent contributor, separate from TheStreet's regular news coverage.

Richard Cox is based in China, and has lectured at several universities there on international trade and finance, focusing primarily on macroeconomics and price behavior in equity markets. His articles appear on a variety of Web sites, including MarketBulls.net, Seeking Alpha, FX Street and others. Investing strategies are based on technical and fundamental analysis of all the major asset classes (stock indices, currencies, and commodities). Trade ideas are generally based on time horizons of one to six months.

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