Why is gold finding support at this level?

While the Federal Reserve teaming up with five other central banks around the world has set gold on pace for its biggest weekly gain in over a month, it is important to recognize that gold demand continues to remain strong.  We have discussed in the past how hedge fund managers such as David Einhorn purchased 1.35 million shares of Barrick Gold in the third quarter, along with a new 1.9 million share stake in the Market Vectors Jr. Gold Miners ETF.  In addition to hedge funds buying gold, central banks continue to buy gold.  The central bank of South Korea announced that it purchased 15 tons of gold in November, which brings its gold reserves to 54.4 tons.  The purchase shows the changing sentiment towards the safety of fiat currencies.  Earlier this year, South Korea’s central bank purchased gold for the first time in 13 years when it bought 25 tons of it in June and July.

Lee Jung from the central bank said, “The Bank of Korea purchased gold last month in a bid to diversify its portfolio of foreign exchange reserves.  Demand for gold is increasing as a hedge against global inflation amid the persistent sovereign debt crisis in Europe.”

Market prices do not show the entire story, but often reflect the mood of buyers and sellers.  As the chart above shows, gold has significant short-term support between $1,600 and $1,680.  After bumping its head against $1,680 throughout October, gold prices broke through and used the price level as support in November.  South Korea is not the only central bank supporting gold prices.  GoldCore reports, “Mexico has bought 98 tons of gold this year, followed by Russia and Thailand, which purchased 63 tons and 53 tons, respectively, with the total official acquisition of gold reaching around 350 tons.”

Another demand for precious metals may come from the miners themselves.  Billionaire Eric Sprott, recently sent a letter to 17 silver producers requesting they store a portion of their reserves in silver, as opposed to devaluing cash sitting in levered banks.  Sprott explains, “Nothing would please us more than to see these companies begin to hold a portion of their cash reserves in the very metal they produce. Silver is just another form of currency today, after all, and a superior one at that.”  He goes on to say that producers should consider keeping a portion of reserves in physical silver that is outside the banking system.  Sprott reasons, “Given the current environment, we see much greater risk holding cash in a bank than we do in holding precious metals. And it serves to remember that thanks to 0% interest rates, banks don’t pay their customers to take on those risks today.”  The current MF Global fiasco playing out certainly does not inject a round of confidence into the financial markets either.

The idea of more precious metal demand coming from producers is not as far-fetched as it may seem.  In a recent interview, Coeur d’ Alene Mines, the largest US based primary silver producer, said it would consider holding some of its reserves in silver at a future point.  CEO Mitchell Krebs told Mining Weekly Online that the miner would be in the position to consider the move in the second half of 2012.  In addition, Coeur d’ Alene would also consider paying a dividend.