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The Gold Stock Strategist analyzes leading junior gold producers and major gold mining companies.

Comments are welcomed!

Friday, April 24, 2009

Is This A Turning Point for the Price of Gold?

I don't need to tell readers of the Gold Stock Strategist how disappointing the share prices of junior gold producers have been over the past year or so. The global deleveraging hit all equity prices hard.

No one predicted junior gold producers would still be about 50 percent off of their highs despite the price of gold having risen from $835 an ounce in January 2008 to $912 an ounce in the fourth week of April 2009 -- a 9.2 percent gain over 16 months.

Input costs have drifted downward. Energy has dropped from about $70 a barrel to $50 a barrel. Labor supply has increased as the economic recession has taken hold, which means the marginal cost of labor should be down.

Well, based on the fundamentals of international finance, junior gold producers may be in for a lift.

Today, we learned that China has been secretly building up its gold reserves since 2003, making it the world’s fifth largest holder of gold bullion behind the U.S., Germany, France, and Italy. China has boosted gold reserves to 1,054 metric tons of gold in March of 2009, up from 600 metric tons in 2003.

In mid-March 2009, China's Prime Minister Wen Jiabao expressed concern about the potential weakness of the U.S. dollar because China holds about $1 trillion in U.S. denominated debt instruments. If the U.S. dollar falls, the value of China's U.S. foreign reserves declines and they don't want to see that happen.

The Prime Minister stated, "We have lent a huge amount of money to the US. Of course we are concerned about the safety of our assets. To be honest, I am definitely a little worried." In rare comments on another country's financial health, he added: "I'd like to take this opportunity here to implore the United States ... to honour its words, stay a credible nation and ensure the safety of Chinese assets."

Just three weeks earlier U.S. Secretary of State Hillary Clinton urged Chinese officials to keep buying U.S. debt. "It's a safe investment. The United States has a well-deserved financial reputation," she told Chinese television stations while on a China trip in February 2009.

Moreover, the BBC recently reported that China and Argentina have inked an agreement in March of 2009 to bypass the world's reserve currency--the U.S. dollar--for trade purposes making it easier for Argentina to buy Chinese imports directly in yuan. (Does anyone else see the irony in having the Argentines concerned with the value of the U.S. dollar?)

Some pundits suggest that the Chinese are bluffing about moving away from their U.S. dollar denominated foreign reserve holdings. And of course, there are a lot of undercurrents and nuance to this story that cut in favor of the bluff theory.

But based on today's news about China's secret gold purchases the question must be asked, "Is China slowly moving away from the U.S. dollar?"

The consequences of China moving away from U.S. dollar denominated foreign reserves would benefit the demand for gold and subsequent price. I suspect China's gold buying news is one reason why gold was up 5 percent this week.

If today was a bullish turning point in the price of gold, junior gold producers look even more undervalued today than they did yesterday.

Counterweights to the turning point thesis are the historical "go away in May" seasonal sentiments for the price of gold.

Only time will tell us what is happening.

Best,

The Gold Stock Strategist

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