The physical gold market has undergone a marked change in the past week

The physical gold market has undergone a marked change in the past week. Until last week the physical market has provided resistance to a higher gold price - now it is providing support. We have seen strong physical selling and scrap gold coming to market since mid-September, as the gold price pushed higher.

However, the latest decline in the gold price to below $1,330 has spurred renewed physical buying interest. As a result our Standard Bank Gold Physical Flow Index (GPFI) has jumped into positive territory after lingering in negative territory for almost more than a month

The buying interest is spurred by two events:
  • Firstly, ahead of the end of Diwali on 5 Nov, India buying interest should remain strong on any price dips. This buying on pull-backs in the gold price may fall away after next weekend. Short term this warrants some caution.
  • Secondly, we believe the buying interest is an indication that the physical gold market is slowly adjusting to the higher gold price and now sees a “higher low” in the gold price as a buying opportunity.

Long term this is a bullish sign. We continue to expect gold physical demand to prevail on dips.
However, the demand on dips might not be as strong as it has been the past month. While Indian demand may fall away towards mid-November, we still have the festive season in the Western
Hemisphere as well as Chinese New Year. In 2011 Chinese New Year is on 3 February.

We note that physical demand is dominated by investment demand. As a result our main focus remains the action of the Fed next week. With regards to the Fed actions - we believe the gold market is pricing $500bn of QEII already. Our estimates are based on gold's close relationship since 2004 with global liquidity of which the Fed's balance sheet makes up an important component. We find a gold price closer to $1,280 would be consistent with no additional QE.

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