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Global swapping of dollars for gold has $2000 per oz in view

Commentaries & Views

On Thursday, Gold Futures breached $1900 per ounce for the first time in eight months after growth in U.S. consumer prices and inflation slowed as forecast in December, aiding the Federal Reserve’s goal of continuing with smaller rate hikes in 2023.

The benchmark COMEX Gold Futures contract has risen over 4% since the start of the year, extending its now 18% rise from a monthly triple-bottom in November. Thursday’s session high of $1906 for February Gold was the loftiest price since May, when the safe-haven metal rose to a peak of $1910.

The Fed’s dialing down of its most aggressive rate-hike cycle in over 40 years has been instrumental in keeping the price of gold elevated since November, with the resulting strong move lower in the U.S. dollar having been a major contributor to bullion’s recovery since Q4/2022.

Another major factor that has contributed to the DXY moving sharply lower has been eastern central banks swapping U.S. dollars for gold. In December 2022, the People’s Bank of China (PBOC) publicly disclosed for the first time in three years that it was increasing the share of gold in its foreign-exchange reserves.

China has been preparing itself to reduce its dependence on the U.S. dollar, as its relations with the United States have deteriorated further following numerous restrictions on Chinese semiconductor companies. The world’s second largest economy has considerably ramped up its gold imports by swapping U.S debt for bullion recently, to diversify its PBOC holdings.

In November an extra 32 tonnes of gold was bought, on top of the usual monthly purchases. This was followed by a further 30 tonnes in December, according to the World Gold Council. For decades, U.S treasuries have been dominant in China’s reserves which could at any time be sanctioned, as has already happened by the U.S. sanctioning Russian central bank reserves.

Moreover, Russia being removed from the U.S. dollar dominated SWIFT international banking system in early 2022 has added to the urgency of diversifying the PBOC’s reserves as fast as possible, with bullion being a good option due to its relative ease of being converted into currency. As an alternative, Russia has adopted China's CIPS (Cross-Border Interbank Payment System) for its oil trades, bypassing the SWIFT global payments system.

This historic move to isolate the Russian economy from the global marketplace has central banks in many countries increasingly worried that they too could be targeted by unilateral Western sanctions. The United States and European Union have frozen, or seized, hundreds of billions of dollars and euros from foreign reserves belonging to the central banks of Russia, Iran, Venezuela, and Afghanistan. This has pushed many nations to begin diversifying their foreign reserves into gold.

By the end of Q3 2022, 673 tonnes had reportedly been added to central bank reserves, a historical high, according to the World Gold Council. In October and November additions continued, with a substantial proportion remaining unreported. This scale of buying has supported the price of gold into 2023.

Furthermore, gold will be a crucial factor for China as the nation looks to strengthen the yuan's international credibility and continues to push forward its plans to buy oil from Saudi Arabia, according to market analyst at BNP Paribas, Chi Lo.

In his latest report, Lo said that if Saudia Arabia started trading oil in renminbi, it would create further momentum for the Chinese currency, bringing it one step closer to reaching critical mass internationally.

"Gold, however, is a key factor in the further development of a petro-yuan system," he said in the report. "A gold-backed petro-yuan does not require full renminbi convertibility to function, so it allows China to simultaneously retain control of its capital account and boost the internationalisation of the renminbi." Lo added that backing a renminbi-oil trade with gold will be instrumental in building its petro-yuan system.

Seasonally, gold can continue its climb throughout January and peak in February, while now being just 5% from multi-year overhead resistance at $2000-$2100. Gold Futures are gearing up for its third attempt at this all-time high resistance zone as it approaches $2000, while becoming overbought on a weekly basis.

The third attempt at a major resistance level is typically not successful. But following a likely pullback from $2000-$2100, gold should make a fourth and successful break to new all-time highs. The $2000 level will then attempt to become the new floor, as opposed to very strong 13-year overhead resistance.

Once gold broke out above the psychological $1000 level after its fourth try in mid-2009, the price had nearly doubled by late 2011. On the downside, if support at $1840-$1850 is broken, there is now strong support at $1780-$1800.

Meanwhile, gold stocks remain under-owned after being shunned by generalist investors for the past two years. Yet, continue to rise with low volume while several long-term bullish sector analysts have been calling for a deep correction to take place over the past six weeks.

After spending the last five weeks of 2022 consolidating outsized gains from a major September low, both GDX and GDXJ broke out above their respective formerly strong resistance levels at $30 and $37 last week. Those waiting for lower entry points into gold stocks, in the form of a sharp correction after both miner ETFs reached those resistance levels in late November, have now witnessed them attempting to become support.

Although the miners have become overbought and are due for a pullback soon, quality juniors still have plenty of catching-up to do. After sector-wide capitulation began in mid-2022, a brutal tax-loss selling kicker took the rest of the weak-handed retail players out of this left for dead sector by year-end.

Once a $2000 per ounce gold price that has been strong resistance for more than a decade becomes a floor, a speculative frenzy in junior mining stocks may already be in progress. Before this relatively tiny sector comes back into favor, it is best to accumulate full positions in select quality juniors on weakness ahead of the coming herd of momentum trader's and institutional investors.

With tax-loss related selling now completed, lower-risk opportunities have been created in quality juniors for contrarian investors accumulating long-term holding positions. During the second half of 2022, the Junior Miner Junky (JMJ) newsletter carefully constructed a concentrated portfolio of exceptional junior resource stocks with 3x-10x upside potential to hold for the next up-leg in the mining space.

If you require assistance in accumulating the best in breed precious metals related juniors, and would like to receive my research, newsletter, portfolio, watch list, and trade alerts, please click here for instant access.

Disclaimer: The views expressed in this article are those of the author and may not reflect those of Kitco Metals Inc. The author has made every effort to ensure accuracy of information provided; however, neither Kitco Metals Inc. nor the author can guarantee such accuracy. This article is strictly for informational purposes only. It is not a solicitation to make any exchange in commodities, securities or other financial instruments. Kitco Metals Inc. and the author of this article do not accept culpability for losses and/ or damages arising from the use of this publication.