Gold Markets Are Not Efficient, Don't Reflect Fundamentals and Understate Gold's Market Value - Part VI
In this part and the next we will look at the prospects for the gold price for the rest of this year and beyond. These next parts are the critical parts. What we will try to do is to synthesize the factors playing on the gold market today and have done in 2013.
The figures put out by the World gold Council are accurate insofar as they project past figures to reach year-end figures. But Sprott's conclusion, we feel, will come true once current restraints on gold demand are removed; however, the WGC/GFMS figures do not paint the day-to-day factors which dictate the gold price today and on a day-to-day basis, nor I believe are they intended to do so. They do paint the fundamental picture, which confirms the fundamental factors that will influence the future. We have great respect for the WGC/GFMS as well as for Mr. Sprott; however we have to synthesize these numbers and influences upon them carefully to see the impact of what is now building up.
The Sea on the Shore
The gold market is split up into three types of factors that take us back to our analogy of the sea-shore. The three elements of the sea at the seashore are the waves, the tides and the overriding currents.
In the gold market these become:
- Waves - The short-term, day to day moves of the gold price driven by speculators, traders, high speed trading and the triggering of stop loss protections. These can be as small as day-traders, taking positions in the morning and closing them before the close of the day. They can be as large as the bullion banks throwing huge amounts of gold at the market to force it to be volatile, while making enormous profits in the Futures and Options markets. They too close their positions so that over time, the ebb of the waves is covered by the flow. This is a constant two-way action of volatility that traders milk for profits.
- Tides - The overall trend of the gold market, as defined by the short- to medium-term Technical picture of the gold price, driven by price factors governing mining, scrap sales investment buying/selling and temporary factors influencing the gold price directly (such as gov't regulations).
For instance, if the gold price goes below the total costs per ounce involved not just in terms of producing the gold, but in terms of pleasing shareholders, then production will be cut back with costs to the more profitable ore reserves, cutting the volumes of gold produced. Once prices rise, the lower grades of the mines become profitable and return to production.
Likewise, where government regulations are imposed to curb imports of gold, it's usually short- to medium-term after which the regulations are changed to permit inflows. If this does not happen, smuggling of gold into the country starts to make up for the cutback caused by regulations.
- Currents - The fear and uncertainty in currency markets reflecting fundamental flaws in the monetary system added to changing global cash flows, particularly from the main emerging nations who favor gold as financial security.
The key current factor is the belief -- particularly in the developing world -- that gold is financial security above all else. This includes emerging world governments who have joined the quest to gather gold into their nation's reserves.
Now the need to synthesize these three patterns of behavior and constantly weigh the influence of each one, that day, is the hard part, but it is this that dictates the gold price and where it's going.
2013 Points the Way
This year of 2013 has been a remarkable on in that it highlighted dramatically the interplay of current market forces with a structurally changing demand/supply picture. This year has seen an ebb tide in the gold price, reinforced by a tsunami from speculators in April and is moving to a point where we are going to see a totally different picture to the one we have seen for more than a year now.
2013 has seen the first two factors dominate until now.
The year started with the ebb tide of U.S. sales from the SPDR and other gold ETFs selling gold persistently, but not so heavily as to crush the gold price around $1,650. This was tied to the belief that U.S. growth turned equity markets into better bets than the gold price. It was notable the ETFs outside the U.S. of A. were not sellers of gold, not even now.
As gold's lackluster performance persisted through to the second quarter of the year with speculators in the form of the big U.S. banks and their clients seeing that as the quiet time in the year for Indian gold demand approached and that U.S. gold sales would persist - laid a plan for a massive 'bear raid'. Slowing deliveries of gold to China also helped prevent that demand from kicking in too much, at that time too, evidenced by the premiums over the gold price seen there this year.
The 'raid' was well engineered as short positions were taken in the Futures and Options markets to profit from the raid. Then U.S. physical stocks of gold in excess of 100 tonnes were thrown at the market suddenly, swamping the gold price and knocking it down to eventually reach $1,180, with $200 being knocked off the price in two days. After this the gold price began to turn back up.
But remember, the U.S. only accounts for 7% of annual gold demand. The holding of the U.S. gold ETFs fall into two categories, the long-term holder looking for long-term financial security and the profit-seeking, short- to medium-term, trader. How much of the holdings fall into one camp or the other is impossible to say, but we believe that the total holdings have halved in 2013. When they cease, U.S. influence over the gold price will cease as well, unless the U.S. turns a buyer.
The raid was a tsunami, not just a wave. But like all waves, no matter what their size, the ebb was followed by the flow back into gold. Today, we see speculators are long of gold again on the COMEX gold futures market. But the banks have not gone back to the physical market to buy back their gold. This was a very heavy hit for the gold market, from which it is still recovering. But it was a one-off. Because of the huge amount sold out of the U.S., it is unlikely that it will be bought back again. This leaves such discretionary stocks at a very low level now, preventing a repeat of the exercise. If the banks and their clients wanted to repeat the story they would have to buy somewhere in the region of 400 tonnes of gold. That is just not available except over a long period in a rising market. As for the sellers of gold, from the ETFs they would now have to buy back around 700 tonnes of gold. They would have to pay up heavily for that!
Last Century's Hedging
A bigger but similar parallel to this was the hedging by gold mines towards the end of the last century when they hedged future gold production at around $400 an ounce or lower. When the gold price pushed through this level, the mines were forced to unwind their hedges and ended up buying back around 3,000 tonnes. This took the gold price over $1,200 from around $400. But this time there would be no central bank suppliers of gold.
Then after April's exercise, the 'current' kicked into the picture and Asian demand from India (ahead of the gov't blocking of exports) and from China came in and took all the gold sold from the U.S., re-refined it in Switzerland and shipped it to the Far East.
Thereafter, through the year, the Indian government, fearful of a rising current account deficit, decided to wage war on gold through raising duties and, in August, passing regulations that could not be met fully by most gold importers there. They have succeeded in cutting back imports to around 10% of 'normal' levels since August of this year. This is a 'tidal' influence which changed the picture for the gold price in the third quarter of the year and continues to restrain the gold price even now.
Usually India's responsible for up to 930+ tonnes of gold imports a year. From August on, gold imports have been forced down to 3.5 tonnes in August and 7 tonnes in September. In the past, this would have been sufficient to send the gold price tumbling.
Add to this contraction of demand U.S. sales of gold and banks forecasts that gold would fall to $1,000 would have been correct but for a major 'current' influence from China. So what has happened because of U.S. ongoing selling and little Indian buying? The price continues to climb gently. Why?
Where Next for Gold?