February could be a weak period for physical demand

Gold held up well until yesterday morning when weaker equities and the stronger dollar started to weigh on all commodities. With gold breaking out of the lower end of its recent trading range, we now find it difficult to see major upside for the metal in coming weeks.

Currency fluctuations and appetite for gold in the physical market guide my analysis. While physical demand has not been exceptional, we have seen a steady buying interest during the past few weeks. This physical buying interest has no doubt supported gold in recent days. This physical demand is evident in how gold denominated in euro outperformed gold denominated in dollar — despite ETF holdings falling.

February could be a weak period for physical demand. Last year, between February and April the volumes of scrap gold that came to the market were large (as evident from the negative values in my index during that period). While there is no guarantee that such selling will be repeated, we may advise caution. From physical flow index has indicated higher buying interest than the same period in 2009; this is bullish. Some of the demand seems to come ahead of Chinese New Year (due on 14 February). However, note two observations:

1. Firstly, last year Chinese New Year was on 26 January. Thereafter, physical selling started. This year, the Chinese New Year is three weeks later, on 14 February. Because Q1 is traditionally the weak jewellery period of the year, and should we see weakness in physical demand, this may not be the case until mid-Feb.
2. Secondly, the current downward pressure which the dollar is putting on the gold price could motivate more scrap selling as investors try to cash in on high prices.
   

While we believe gold will test new highs in H2:10, the recent developments in financial markets and past evidence from the physical market seem to advise caution on gold for the next few weeks.