Why Gold Flows Is The Key To Precious Metals Prices

Annual global new mined gold output is circa 3,200 metric tons. 

Chinese and Indian gold demand alone comes in at around 2,800 tons – perhaps more as India is an important destination for smuggled gold (perhaps 250 tons a year) which doesn’t appear in any official statistics.  Russian central bank gold purchases are currently around 200 tons annually.  Other official gold holdings increases – notably in Kazakhstan and Turkey - are coming in at around another 200 tons a year based on official IMF year to date figures. 

Gold ETFs on balance this year have been adding gold (just), although there have been some recent high profile liquidations – notably out of the USA’s biggest gold ETF – GLD which has seen around 72 tons liquidated in the past five weeks.

Overall, therefore, we are beginning to see a physical gold deficit in the West without even taking into account any demand from the world’s other 190 plus nations.  Scrap supply will fulfill some, but not all, of the balance unless there is a big gold price boost at which gold sourced from scrap may pick up, but probably not sufficiently to satisfy global demand which would probably rise along with the price – momentum trading. 

A Short Squeeze in Physical Gold?

We could, therefore, be facing a major short squeeze in physical gold – a premise supported in recent internet articles by Jim Rickards and on the investing.com website quoting Lior Gantz, founder of Wealth Research Group.  Both point to a squeeze on supplies at the Swiss refiners which, anecdotally, are having difficulties in sourcing sufficient gold bullion to meet demand.  Gantz is quoted as commenting:

“I even called in to some of the larger Swiss bullion dealers, as a would-be customer with a large order, and they informed me that if I want physical shipment, ‘I should experience severe delays.’ One dealer said they had been emptying parts of the vaults they hadn’t used in 14 months!”

Rising Price of Gold

Rickards has also reported similar conversations with the Swiss gold refining sector.

To put this in balance, precious metals consultancy GFMS takes a slightly different view suggesting that although gold demand is up in the first half of the current year, and new mined gold supply is down, we could yet be heading for a gold surplus for the full year and the price will fall back to around $1,200 from the current $1,260. 

But we disagree.  This is because H1 increases in global gold ETFs are well below those of H1 2016.

We reckon, however, that GFMS hugely underestimates real Chinese demand in particular which it puts at around 292.7 tons, but latest figures out of Switzerland puts H1 gold exports to mainland China and Hong Kong (the vast majority of which will also move to the Chinese mainland) at a combined 343.7 tons, and China sources gold from a number of other nations directly as well. 

Add in China’s own production of some 225 tons in H1, plus direct imports from countries like Australia where exports to China+ Hong Kong appear to be booming and hit 57 tons in Q1, and this suggests a far larger figure for total gold absorption by China alone.

So why is the price not going through the roof?

Gold has always had a brilliant passive marketing base. We are mostly brought up from our childhoods, even in the West, with tales of gold as being a, perhaps the, prime indicator of wealth and success.  How much more so in Asian and Middle Eastern nations where gold as a store of wealth is inbuilt into the psyche – and Asia alone accounts for around 60% of the global population. 

With growing wealth in the region we are seeing rising demand for precious metals from these nations in particular. With physical gold continually heading east – 90% of the Swiss gold exports in June for example were headed to Asia and the Middle East – this will likely lead to imbalance in gold availability in the West.

The principal answer is that the gold price is set by, at least for the moment, the gold futures markets rather than by physical supply and demand parameters.  Various entities – notably governments, central banks and their bullion bank allies - have a vested interest in controlling any upwards movement in the gold price as a high gold price tends to be seen as indicating all may not be well with currencies and the economy, an indicator which runs contrary to the picture they would rather have us believe. 

These controls may be exacerbated by high frequency algorithmic trades which look for stop levels and initiate sales down to these levels, or occasionally up to them, until the market resets, and usually makes at least a tentative recovery.

Some followers of the gold market have pointed out that the media, and the gold investment community, seems to seize on these occasional downward flash crashes as proof of collusion in suppressing precious metals prices, but without attributing upwards movements to any manipulation of the markets.  But it is also worth pointing out that the recent downwards flash crashes we have seen have seemed to involve the instantaneous sale of huge volumes of metal while corresponding mega purchases are not evident in the upwards movements. 

As an example the most recent gold flash crash, on June 26th, saw 56 tonnes of gold (worth over $2 billion) dumped on the market in around a minute.  That seems unlikely just to be some arbitrary trade initiated by a computer algorithm – or a ‘fat finger’ trade as the media tends to explain it.

While gold may not be totally dependent on the supply/demand equation like other commodities – some would argue that it’s not really a commodity but is money and behaves more like a currency, and a strong one at that – supply/demand fundamentals can, and will, have an impact and there’s little doubt that in terms of these fundamentals the yellow metal is becoming scarcer. 

New mined production looks to have peaked – or if it is still rising it is only doing so in infinitesimal amounts and there’s no likelihood of any major supply boost in the years ahead.  We see demand as continuing to rise as the global population and cumulative wealth increases and we are therefore coming into short squeeze territory – indeed we are quite probably already there. 

At some stage we would certainly anticipate that this overt shortage of physical metal will drive the price upwards whatever the paper gold (futures) market may try and do – and this would be completely independent of external factors like U.S. Fed interest rate policy, but could be exacerbated (enhanced) by any major turndown in the equities markets, which more and more commentators seem to suggest may be imminent.

How Does This Affect the Price of Silver?

But, what of the other metals deemed as falling into the precious sector.  The silver price, regardless of the sense of this, does seem to be inexorably tied to the gold price, but in a much more volatile manner, despite its big usage in the industrial sector.  When gold rises, silver tends to rise faster, but when gold falls or stutters the reverse is true, and silver falls further and faster. 

As a much smaller market than gold it takes far less money to move it, particularly in the futures markets, which is where we have seen huge volatility in the past, but our advice here is to hold firm – if you are confident in gold’s future, silver may be an even better investment.  The gold:silver ratio (effectively the number of ounces of silver it takes to buy an ounce of gold) is currently sitting at a little under 76. 

Should gold see a decent price increase, we see this ratio coming down – thus if gold hits $1,400 an ounce (around a 12% increase) and the ratio falls to say 65, silver would come in at a little over $21.50 – a 30% plus rise.  We don’t see this as an unreasonable target.

Does Gold Affect Platinum & Palladium Prices?

As for platinum and palladium, although these do tend to move to an extent with gold and silver, they are in reality industrial metals and major markets for them, notably auto catalysts, should ultimately be a bigger influence than the gold price. 

While demand in this sector is strongish, as ever more stringent emission control legislation has a positive effect on demand, and fundamental metal shortages are affecting price, longer term we see this as potentially a severely declining market as legislation is currently moving in favor of non-polluting electric vehicles (EVs) and this trend is developing faster than even the most bullish EV proponents would have contemplated even a year ago.  

European legislation, for example, seems to be moving in favor of banning internal combustion engine driven sales by 2040, and we see the even larger Asian markets, particularly China, going down the same route.  China is already producing enormous numbers of EVs and even the more conservative North American manufacturers are beginning to jump on the EV bandwagon.

But the above is something of a digression from the overall premise of this article.  Physical gold is very definitely flowing principally to Asia and these markets tend to absorb it without re-releasing it back into the global market.  These are much firmer hands than we see in Europe and North America in particular and this is certain to lead to very tight, if not short, supplies in the West if precious metals become more favored by investors, as we think they will – particularly if we see the much forecasted equities market downturn developing.

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