Archive for Gold Briefs

CHINA GOLD: MORE THAN MEETS THE EYE

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The gold world has lately been abuzz with news and speculation about the true volumes of gold supply, private-sector demand, imports, and central-bank reserve accumulation.

In recent weeks, every gold analyst and pundit seems to be jumping on the bandwagon.  But this is nothing new for our clients and readers of NicholsOnGold.

For several years now, we have suggested that China’s actual annual gold production, consumption, and imports have been running considerably higher than that suggested by official and semi-official statistics coming out of the Asian giant - and that China’s central bank has been accumulating many tons of gold each year but for now chooses not to report these purchases in the country’s official reserve statistics.

Indeed, I’ve been talking about surreptitious gold accumulation by the People’s Bank of China (the PBOC) ever since my speech to the China Gold & Precious Metals Summit in 2008 (see http://nicholsongold.com/2008/12/the-world-economic-crisis-and-the-outlook-for-gold-speech-to-the-china-gold-summit-december-4-2008/) — and I’ve been reiterating this theme in speeches and reports ever since.

Underestimated Supply

China’s total gold supply from domestic mine production and other sources is, without a doubt, much higher than reported or discussed by analysts and observers of the Chinese gold scene. Actual gold mine production - and supplies from other sources - could easily be close to 400 tons and possibly much more.  Here’s why:

  • The China Gold Association (CGA) numbers reflect production by their members only — but omit gold mined by non-members. These include many small, often rudimentary, unofficial mining operations some of which are illegal existing in the “underground economy,” no pun intended.
  • The CGA data also excludes production from mines owned and operated by the military, which is significant according to my sources. And not to be overlooked is by-product output from the country’s copper, silver, and other metal-mining activities. Again, this is significant though hard to know just how significant.
  • Also missing from the CGA reports are the huge quantities of gold contained in copper and other precious-metals bearing concentrates imported and processed by Chinese smelters and refiners.
  • In addition to these unreported sources of supply, analysts and commentators seem to forget about secondary supply — that is from recycling of jewelry, investment bars, and industrial scrap. Just to get an “order-of-magnitude” possibility, in recent years global secondary supply from scrap recycling has contributed more than one-third of total world supply. If scrap contributed only five or ten percent of China’s total gold supply it would still be quite important.
  • Western analysts estimate China’s total gold imports last year were around 490 tons — but there is little mention of “illegal” imports — that is gold smuggled into China. We know smuggling is quite significant in some countries — Vietnam and India, for example. We can only imagine how many tons of gold in the form of tael bars, wafers, coins, investment-grade jewelry, etc. is carried into China each year by travelers and professional smugglers.

Central Bank Gold

Now, what about net purchases and total official reserves held by the People’s Bank of China?

Chinese miners and refiners are required to sell each and every ounce of gold output to the state gold-buying authorities.  But, it seems that some of this (more or less the volume of unreported production, as discussed above) is retained by the PBOC and other government entities acting on behalf of the central bank.

It is not at all unreasonable to conclude that the Chinese government may be squirreling away perhaps 50 to 100 tons a year into accounts that will eventually be included in the country’s reported official reserve figures - and one might speculate that these figures could turn out to be considerably higher.

In my most recent speaking tour on behalf of clients across China late last year and published on my website on December 15th (see http://nicholsongold.com/2011/12/797/), I said:

In recent years, China’s central bank, the People’s Bank of China, has also been a significant buyer.  Two and a half years ago - in April 2009 - the PBOC revealed it had bought some 454 tons of gold over the preceding six years, an average of about 75 tons per year.

Since then there has been no hard evidence of additional buying . . . but my guess is that your central bank continues to buy regularly from domestic mine production and scrap refinery output - perhaps as much as 50 to 100 tons per year.  For its part, the PBOC not long ago said it will “seek diversification in the management of reserve assets,” possibly implying their intention to accumulate gold without actually saying so.

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Un-Seasonal Expectations

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Despite the winding down of East Asia’s Lunar New Year gold buying binge, I expect the yellow metal’s price will continue to move up in the weeks ahead - but not without some struggle as gold works to reestablish upward momentum and renewed credibility.

Historically, with the arrival of the Lunar New Year, gold demand and the metal’s price typically enter a seasonally weak period — but the typical seasonality is no longer a reliable guide to gold price prospects.

The usually weak summer months this past year saw gold run up to new historic highs above $1,900 an ounce . . . and, contrary to expectations, the seasonally strong autumn months saw gold prices fall sharply, all the way back down to $1,525 or thereabouts.

Changes on the Demand Side

Now, with winter upon us, I don’t expect gold prices will drop with the temperature as they often have at this time of year.  Instead, I believe that there have been important changes on the demand side of the gold market that now overpower or outweigh any remnants of seasonality.

For one thing, institutional investor participation has grown by leaps and bounds, as has retail demand for bullion coins and small bars.

Similarly, official-sector gold accumulation has become an extremely important non-seasonal factor effectively removing several hundred tons of gold from the market in each of the past two years.

I expect central bank demand not only to continue but possibly expand in 2012 with China and Russia leading the pack — and a growing number of countries underweighted in gold relative to U.S. dollar-denominated reserves joining in this official-sector gold rush.

These buyers - private investors and governments alike - don’t care what the weather is.  Instead, their behavior is a reaction to macroeconomic and political developments in their own countries and around the world without regard to the time of year.

And, institutional traders and speculators - who lately account for much of the short-term volatility in the metal’s price - are often governed by new and changing trading modalities and algorithms.

For example, the increased importance of “portfolio rebalancing” by index, commodity, and hedge funds has, for now, introduced a new element of seasonality, one that weighed heavily on gold in late December and early January when many of these funds were large-scale sellers of gold, mostly in futures and other derivative markets, but nevertheless with negative price consequences that are now past.

Shrinking Free Float

Continuing Chinese gold accumulation has important long-term significance that is not generally acknowledged by many gold analysts and market pundits.   Simply put, China’s private-sector gold purchases are unlikely to be sold back to the world market any time soon, certainly not for many years to come and even at much higher prices.

Not only are gold exports from China illegal - but many, if not most, Chinese savers and investors buy gold with no intention of selling sometime in the future just because prices rise, inflation subsides, equity prices tumble, or any of the other drivers that might trigger sales by Western investors.  For the Chinese, these are long-term, quasi-permanent holdings.

The same can be said of central-bank gold purchases, not just by the People’s Bank of China, but by most of the central banks that have been building gold reserves in recent years.

As a result, the supply of available gold in the marketplace — what I call “free float” – is diminishing . . . and any pickup in gold demand for jewelry, investment coins and bars, official reserve accumulation, etc. will have a more high-powered affect on the metal’s price than might have been the case a few years ago.

More Money Will Fuel Gold’s Ascent

Prospects of further monetary easing by the world’s three top central banks - the U.S. Federal Reserve (the Fed), the European Central Bank (the ECB), and the People’s Bank of China (the PBOC) - also know no season and are also becoming more supportive.

In each region, signs of slowing economic activity, unacceptable or worsening labor-market conditions, and continuing restrained consumer price inflation suggest that central banks will press harder on the monetary accelerator in the months ahead.

As in the past, quantitative easing or other steps to raise credit availability by the Fed, the ECB, and the PBOC could fuel surprisingly big moves in the price of gold in the months ahead.

Wild Cards

Finally, there are a number of “wild cards” that may affect gold prices - for better or worse - in the days and weeks ahead.  At the top of my list:

  • America’s political log-jam and Washington’s inability to reach a consensus on important federal debt and budget measures;
  • Heightened tensions in the Middle East - with saber-rattling by Iran, oil-price uncertainties, approaching Egyptian elections, and the threat of civil war in Syria;
  • Europe’s continuing sovereign-debt crisis, further downgrades by the credit-rating agencies, the looming Greek default and departure from the euro-zone, possibly followed by other deeply indebted countries.
  • And, perhaps most importantly, how the U.S. dollar reacts in world currency markets to any of these unfolding developments and to further monetary easing by the U.S. Fed.

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GOLD PRICE TO SNAP BACK

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(Posted January 9, 2012)

In contrast to the closing months of 2011, gold has begun the new year on a more positive note.  Whatever the metal’s short-term prospects — indeed even if gold takes another dive — we believe 2012 will be another stellar year for gold investors.

Gold topped out at an all-time high just over $1,924 an ounce in early September - a whopping gain of some $600 or about 50 percent from last January’s low point.  But as investors know all too well, gold prices can be quite volatile - with big upswings often followed by big downswings, albeit around a rising long-term trend.  Such has been the experience of the past four months with gold shedding roughly 30 percent from its all-time high to its recent late-year low point of $1,522.  But, let’s not forget, even allowing for this deep price correction, gold still closed the past year with just about the best annual gain of any asset class!

Looking ahead, 2012 could well turn out looking much like the past year for gold - with sizable gains, possibly as much as 50 percent (or more) from the recent lows, but also with occasional big declines that may lead many observers of the gold scene to mistakenly declare an end to the yellow metal’s bull market.  Just as gold bears have been wrong over and over again in the past decade, so will they continue to be wrong in 2012.

The story of gold in recent years has been a tale of institutional traders and speculators - including hedge funds, commodity funds, and the trading desks at the big banks and financial firms - producing great two-way volatility as they rushed into gold (as we saw last summer) and then, not just unwinding long positions, but shorting the metal in a big way (as we saw this past fall).

Driving these institutional players, in addition to momentum and technical trading indicators, has been the flight from the euro into U.S. dollar assets - and the appearance of dollar strength pushing gold lower, particularly at times of massive euro capital flight.

Importantly, much of this negative activity has taken place in gold derivative markets - but, all the while, long-term physical demand has remained fairly robust.

Buying from the Asian gold-market giants - China and India - for both jewelry and investment has continued to remain firm in spite of higher prices that years ago might have discouraged continued accumulation.

Having just returned from two weeks in China and meetings with many players in the country’s gold market, I can tell you that gold demand remains strong despite the recent slowdown in economic activity, thanks to personal income growth albeit at a slower pass, rising wealth among those most likely to buy gold, and also inflation fears.  Moreover, higher gold prices, rather than discouraging demand, have attracted new investors to the market.

Meanwhile, global net central bank gold buying has not just continued but has accelerated as reserve managers look for opportunities to shed U.S. dollars — and euros too — in favor of something that has a longer track record as a reliable store of value.

Central bank reserve managers, ever sensitive to buying without disrupting the market, have used episodes of price weakness to step up their buying.  This behavior now reduces downside risk while it is also helping set the stage for a surprising sizable snap-back in the metal’s price.

What few gold pundits realize is that the amount of physical gold available in the world gold market - the “free float” - is shrinking, thanks not only to Chinese and other Asian buyers, many of whom are unlikely to sell, but also due to renewed interest and accumulation of gold by a growing number of central banks.  For central banks, the holding period may be measured in decades if not longer.  As a consequence, future demand will have a much more high-powered affect on the price of gold - and this is one of the reasons we expect much higher prices in the years ahead.

Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility — and can trigger significant price corrections — but, in my book, it does not affect the long-term price trend.  What governs the price of gold over the long term are the market’s real-world supply and demand fundamentals - and these have been decidedly bullish and are becoming even more so.  Hence, my long-standing long-term forecast of higher gold prices over the next several years.

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Gold - Recovery and Resurrection

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Gold is coming to life again - and looks poised to move higher in the weeks and months ahead.  Having fallen precipitously from its all-time high just over $1,923 an ounce in early September to a recent low near $1,540 in early October, a peak-to-trough correction of some 20 percent, gold has been, of late, range-bound, trading between $1,640 and $1,680.

Having moved to the top of this range and even slightly higher, I sense gold is just now resuming its long march upward, a march that could, before long, carry the price to the $1,850 region and perhaps even to its historic peak of $1,923 by the end of the year.

The Safe-Haven Paradox

Ironically, Europe’s continuing sovereign debt crisis - a situation that should promote fear-driven demand for gold - has, in recent weeks, weighed heavily on the yellow metal’s price.   In addition, a sharp reversal in speculative positions on futures exchanges and other derivative markets has contributed to gold’s two-month consolidation.

Ordinarily, investors and analysts might expect Europe’s impending economic and political disaster to send gold prices rocketing skyward - but this has not yet been the case.  Instead, it triggered “safe haven” demand for the U.S. dollar and boosted the greenback’s exchange rate against the euro to gold’s detriment.

With flight capital and hot money going into the U.S. dollar as a safe haven from Europe’s woes, dollar-denominated hard assets like gold and other commodities have been under pressure, in large measure due to the behavior of institutional traders and speculators, many of whom have reduced their “long” positions or “shorted” gold in derivative “paper” markets.

Gold’s Fortunes Set to Improve

I have no doubts that the recent downward pressure on the gold price arising from the U.S. dollar’s “apparent” strength - and I stress “apparent” - will prove to be temporary.   Indeed, in recent days, with demand suddenly surging for investment-size bars and gold exchange-traded funds, it looks like safe-haven gold demand may finally be picking up even as the flow of funds into the dollar continues.   ”

In any event, gold’s fortunes are set to improve in the weeks ahead:  If Europe’s debt crisis subsides, the dollar will no longer benefit from its safe-haven role.  If it continues to worsen, investors, particularly in Europe, are likely to accelerate their rush into physical gold, buying bullion coins, small bars, and ETFs, as they did in mid-2010 when Euro-angst was, like now, at a feverish pitch.  But, either way, as traditional physical demand continues to grow, especially in Asia and from central banks in that region and elsewhere, gold is increasingly going into stronger hands that are less likely to sell even at much higher prices.

Short-term trading in derivative markets may, at times, produce a great deal of gold-price volatility but, in my book, it does not affect the long-term price trend.  What governs the price of gold over the long term are the market’s real-world supply and demand fundamentals - and these have been decidedly bullish . . . and are becoming even more so.  Hence, my long-standing long-term forecast of higher gold prices over the next several years.

Robust Physical Demand

While speculative pressures have pushed gold lower, physical demand has remained quite firm - not just from European’s seeking a safe haven - but, even more so, from Asian markets, particularly India and China, where investors and consumers are taking more gold for reasons that have little to do with the world political and economic situation.

India, for example, is now celebrating (this year beginning on Wednesday, October 26th) the Diwali “festival of lights.”  Considered an auspicious time to buy gold - investment-grade jewelry, small bars, and coins - Indians are showing no reluctance to acquire gold at what are historically very high rupee-denominated prices.

Our friends in the Indian bullion community expect continued strong physical demand in the months and years ahead - reflecting growth in personal income, particularly in the agrarian and rural communities that traditional buy and hoard gold, as well as worrisome domestic inflationary pressures.  Not to be understated, India’s central bank purchase of 200 tons of gold in 2009 was an official endorsement of the metal’s role as a reliable store of value and savings asset that many private households are now following.

Chinese gold demand is also robust, due to income growth, rising wealth, and also inflation fears.  Higher gold prices, rather than discouraging demand, have attracted new investors to the market.  And, the central government has been pro-active in promoting investor access to gold by encouraging the development of physical and futures exchanges and retail gold distribution through banks and other retail outlets across the country.

Sticky Gold

Not counting official purchases by the People’s Bank of China, Chinese consumers and investors are now the world’s biggest end-market for gold.  And, this is long-term “sticky” demand, much of which is unlikely to come back to the market anytime soon, perhaps not in our lifetimes, even as the metal rises to a multiple of today’s price.

In addition to solid private-sector physical demand, the official sector has been an increasingly important buyer.  Russia and China have been most prominent, buying fairly regularly and stepping up acquisitions whenever the price dips as it has in the past couple of months.  The list of central banks buying gold this year includes South Korea, Mexico, Kazakhstan, Thailand, Bolivia, and Colombia.

With both the U.S. dollar and the euro looking tarnished and risky to central bank reserve managers, official-sector gold acquisitions have likely increased in recent weeks at lower price levels where purchases could be made discretely without any noticeable affect on gold-price volatility.  And, this too, is sticky gold that is unlikely to return to the market any time soon.

What few gold pundits realize is that the amount of physical gold available in the world gold market - the “free float” - is shrinking, thanks not only to Chinese and other Asian buyers, but also due to renewed interest and accumulation of gold by a growing number of central banks.  For central banks, the holding period may be measured in decades if not longer.  As a consequence, future demand will have a much more high-powered affect on the price of gold - and this is one of the reasons we expect much higher prices in the years ahead.

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