Physical Demand in Asia Boosts Gold to Strong Start in 2014

Gold extended its rally on Friday, climbing to a two week high, after closing 2013 with losses of almost 30 percent. 2013 was the first losing year for bullion after 12 years of consecutive gains.

The New Year's rally was ignited by reports of rising demand for gold bars and jewelry in Asia, notably China. According to the World Gold Council, China was the largest buyer of gold in 2012, followed by India. A sharp selloff in equities on Thursday also contributed to demand for the metal as a safe-haven asset.

Fed Policy

Gold reached record highs of $1,920 an ounce in September 2011 as central banks collectively engaged in dovish fiscal policy. Investors flocked to gold as a hedge against inflation as the value of currencies were eroded by central bank stimulus.

However, the Fed announced last month that starting in January, it will taper its monthly bond buying to $75-billion from the $85-billion pace started in September 2012, citing "meaningful" progress in the jobs market. The news initially triggered a sharp selloff in gold.

Tame Inflation

The low rate of US inflation served to dampen demand for gold as a store of value in 2013. The Federal Reserve has a dual mandate to pursue both maximum employment and stable prices. Inflation, as measured by the PCE Price Index, averaged an annual rate of 1.2 percent in the third quarter, well below the Fed target of two percent.

Unemployment Threshold

The Fed has stated that it won’t raise interest rates until after the unemployment rate reaches a 'threshold' of 6.5 percent or lower, signaling that accommodative policy could last well into the future. While many analysts suggested last year that ongoing stimulus would bolster gold, that proved to not be the case in 2013.

COMEX Gold Futures Daily Chart

Looking at the daily gold futures chart we can see price is well below both the 50 and 200 period moving averages and that the prior low of 1181 forms potential support. A substantial break beneath that level would leave gold vulnerable to sellers, with little nearby support and prices unseen since 2010.