Gold Markets are not Efficient, Don't Reflect Fundamentals and Understate Gold's Market Value (Part 7)
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 critical. What we will try to do is to synthesize the factors playing on the gold market from the beginning of 2013 up until the present day.
What we've pointed out is how easy it is for the bullion banks -who are distributors of gold globally as well as speculators and brokers to so many of the huge professionals in the gold market as well as for themselves--to 'manage' the gold price to where they want it to go; however, they cannot override the underlying current of the gold price. They can manage individual waves and can for a while manage the tidal effects, but when you see the fundamental changes happening in the gold market globally, even the professionals in the gold market cannot override them of influence the changes in current for more than a short time.
With the fragmentation of the gold market, as we're describing in this series on the gold market, the gold price is not reflecting the true balance of demand and supply. It's reflecting the balance of the demand and supply that's routed through London and other developed world markets and distribution systems. This doesn't represent the entire gold market, and yet gold prices paid between buyers and sellers in the entire gold market are still referenced to the developed world gold markets, particularly the London Gold Fixings.
If the gold price is to represent the entire gold demand and supply balance, there are only two ways forward:
- The first is for the current bullion banks to set up an efficient distribution system in Shanghai, with its own Fixes to directly supply Chinese buyers and sellers.
- The second is for Chinese banks to set up and copy the operations of the London Bullion Banks. We expect the London Bullion Banks to be cut out, if they don't adapt.
This is where we must be careful when it comes to statistics. The numbers put out by the World Gold Council and GFMS are, we believe, impeccable. When Mr. Sprott refuted them, it was on the basis that they didn't accurately reflect what the future holds. As historic statistics, at best, they are only an indication of the future market in gold but cannot be relied on to be an accurate portrayal of the future. Price changes alone can dramatically alter demand and supply patterns.
For instance, the enrichment and enlargement of the Chinese middle classes -who buy gold for financial security, not because of a change in the U.S. economy--has nothing to do with the last three decades of gold's history, but only on the jump in their personal income. As such, it is an expansion as well as a new addition to the demand for gold.
So when we talk future prices of gold, we can only extrapolate gold events to a certain extent based on historic figures. The gold world is seeing structural changes that lie outside of these, and this is where the overriding current in the price of gold lies.
Demand / Supply Figures
On top of such changes, we need to understand the impact of specific new events, such as the current block put on gold imports by the Indian gov't.
For instance, Indian demand (see table below) will be 1,102 tonnes in 2013. But the gov't blocks on import of gold have forced that figure to drop to 10% of former levels, so we have to adjust that figure from 1,102 to around 760 tonnes for the year, with only 51 tonnes brought in from August to the end of the year.
Indian demand at 51 tonnes from August onwards is what should be extrapolated, not the pre-August numbers. Where Mr. Sprott will be proved completely right is from the day the gov't blocks on gold imports to India are lifted. Then all that pent-up demand from August onwards will be released and when combined with Chinese and other demand throughout Asia, there will not be enough gold to supply Asian demand.
Look at Thailand's figures. With India raising the duties on Thailand's exports to India, their demand for gold will drop significantly from now on, so their demand must be reshaped in today's context from the table below to only their local needs.
With Indian elections coming up next May, we expect political expediency to require the blocks on gold imports to be lifted, at least temporarily. Once again, this will be an events related to Indian politics, not the gold world as such.
With the gov't blockade on gold demand being a 'ebbing tidal', influence on Indian demand it will turn back to a 'flowing tide' in the medium-term (perhaps within 7 months).
As of now we're seeing a tipping of the see-saw in favor of higher prices as Chinese demand grows and grows. A fortnight ago, the premiums on Chinese gold prices over London's, have evaporated. We ask, "Why were they there in the first place, after all the Chinese gov't is encouraging imports of gold?" We believe that answer is due to the issue by the Chinese gov't of licenses to non-banks. Slow deliveries -maybe to support banks positions in gold?--are now being eliminated as other importers accelerate them. Consequently, the annual imports to China should be higher than the figure on the Table as the force of demand continues to grow.
But these may not be reflected in imports through Hong Kong, as such importers may elect to use other ports of entry, one that will not report their figures.
Additionally, the Chinese gov't favors the purchase of gold mines outside China. Expect the gold from those mines to be channeled into China, not through London, where it would be reflected in the gold price. This way it would bypass that market, which prices gold. But the drop in supplies would indirectly affect London prices. As unsatisfied demand outside of China sees lower availability; they will eventually drive gold prices higher.
Scrap supplies, which are very price sensitive, may be lower than the table suggests, as lower prices deter such supply. In India, scrap sales will be drying up because sellers know they're unlikely to get back what they sell. The addition of premiums over $130 an ounce will not attract long-term holders of gold to sell their gold for the same reasons. Sales of gold by Indians are usually done for a short-term profit, with gold being bought back at lower prices, when supplies from outside the country are sufficient.
These two factors together, will further tighten supply, heavily, in the short- to medium-term, unless prices for scrap rise significantly.
We now turn to ETF sales, which we discussed earlier in the series. Again, we can't accurately extrapolate these because the sales to date, this year, from those funds, represent around a third to a half of their holdings.
Of the remaining holders, we ask. 'How many are holding for the very long-term and how many are waiting for higher prices? Are these holders waiting for U.S. economic growth to establish itself convincingly, or do they believe that has happened already?' If so it is economic growth per se, that will determine future sales, not past sales.
If the remaining holders are not sellers under these circumstances, then these sales will dry up soon. If the current holders are profit-seeking, they will have to wait for higher prices before they sell.
Is there any way we can get an indication of the nature of the sales and whether they will continue? The answer lies in the pattern of such sales. What we have seen lately is a pattern of large tonnages of gold sold at the times of the day in the gold market when prices are at their most sensitive, or when the gold price sits on support levels, telling us that these sellers are not maximizing profits, but instead trying to break the gold price down. Otherwise they would sell in a way that ensured the least impact on the gold price. They would wait until signs that the gold price had reached a short-term peak before selling so as to maximize profits. But they haven't. To sell gold in very large amounts can only be seen as very large sellers wanting lower prices.
In terms of ongoing supplies, we have to remember that gold ETF holdings are finite. Once these sales are complete, they will not return, simply because they have run out of gold to sell. We have labeled that as 'U.S. selling,' which once it stops, once again, will leave the global gold supply insufficient to meet current total global gold demand.
(You will note that in this essay we have not mentioned central bank demand or the return to the monetary stage of gold in a pivotal position. Should this happen, the only access to monetary gold to add to reserves will be from their own citizens. We will cover 'Monetary Gold' in the next part of this series!)