Since the middle of April we have all heard the gold bear
cry of ‘it’s over, gold is done with…the bubble has burst.’ But not many of
these so-called expert commentators have really looked into the strength of
demand in the East.
Jeff Nichols wrote in a note to investors recently that
he believed gold bears ‘have a fairly provincial view and limited understanding
of gold’s increasingly bullish long-term fundamentals.’ He went onto define
‘provincial’: ‘they are ignoring more than half the world.’
I couldn’t agree more.
Total physical gold demand for that half of the world in
Q1 this year was over 740 tonnes.
Comparing these official figures, to those in the West it seems odd that
analysts believe the hunger for gold is quickly disappearing.
That’s just investment demand. Central banks in the
‘ignored’ part of the world shopped up a storm as well, purchasing 109.2 tonnes
in Q1, for the seventh consecutive quarter central bank purchases were over 100
tonnes.
Some central banks embraced the price fall; recent IMF
data shows that in April/May Russian holdings climbed 8.4 metric tonnes to 990
tonnes, Kazakhstan’s hoard increased by 2.6 tons to 125.5 tons and Turkey’s
holdings increased by 18.2 tonnes.
Not including recent central bank purchases, consumer and
central bank demand very nearly equalled total global gold supply in the first
quarter of the year
Many could argue however that the gold price fall hadn’t
occurred when these figures were taken. In light of this, recent demand is even
more impressive, particularly in the two shining lights of the gold market,
India and China.
In India, for example 300 tonnes was imported between
April and May. June to July expects to see this fall to 90 tonnes, even if this
low numbers is the trend across the summer months, it will still top those
import figures seen in the first quarter.
But India, will lose its crown as the world’s largest
gold importer this year as China is expected to import between 900-1000
tonnes.
Will the Eastern bull survive?
Given developments in some Eastern countries, both
economically and in the gold market, it is understandable that many believe
earlier levels of gold demand are unsustainable.
India’s increase of import duty on gold is one example of
when the gold bears do pay attention to physical gold demand. When the Indian
government announced that they were increasing the import tax on gold from 6% to
8%, in order to fight the current account deficit, everyone said this would
remove some of the underlying support for gold, thereby adversely affecting the
gold price.
At present gold prices in India have not benefitted from
this week’s fall, thanks to the weak rupee and the import duty.
According to reports Indians looking to buy gold are
waiting for further falls, Ashok Mittal, chief executive officer of Emkay
Commodities, told Business Standard, “Indian consumers will wait for to gold
fall further and our view is that RBI (Reserve Bank of India) may not let the
rupee trade so low and will take steps [to manage this]. These will make gold
cheaper for Indian consumers.”
Whilst gold imports are estimated to fall by 25 – 30% as
a result of government efforts to slow gold demand, you can bet there will be
increasing numbers of reports covering gold smuggling. One asks how the
authorities will manage this as well as checking those Indian citizens who fly
in from the Middle East.
Of course, it seems too good to be true to present an
argument based on illegal behaviour and unofficial figures. But one must
consider how easily citizens of a country will switch to a dramatically devalued
paper currency when all they have ever saved in is gold.
Discussing his country’s obsession with gold in relation
to balancing the deficit, novelist Chandrahas Choudhury wrote the following:
“As the late Indian economist IG Patel, who wrote
extensively in the 1950s on India’s gold obsession and ways in which to mobilize
the hoarded wealth, once said: “In prosperity as in the hour of need, the
thoughts of most Indians turn to gold.” The evidence from the last few years
suggests that when steeply rising prices, and a debilitating current account
deficit that raises the cost of other goods, come up against a powerfully
entrenched cultural reflex, it’s not always the laws of economics that win
out.”
It depends whose economics you follow, but either way
Choudry and I both agree that gold will win this battle.
China is where the real action is
In China it is virtually the opposite story to anywhere
else in the world. Yet it is so quickly dismissed by ‘experts’ that one wonders
if there is an ulterior motive. Recent concerns over manufacturing levels and
this week Shibor, have led many to conclude that gold will find little support
in the increasingly troubled country.
One of the many ‘indicators’ that the gold price could no
longer find support was because of a fall in imports from China. Whilst China’s
gold imports fell from April to March, the month’s imports were still amongst
the highest on record.
However, unlike India and Vietnam (whose government
heavily controls the gold market), the government has no incentive to control
gold, thanks to the balance of payments surplus. In fact the government are
almost falling over themselves to facilitate gold investment.
Earlier this month two newly approved Chinese gold-backed
exchange-traded products were announced. Hua An Asset Management, a firm behind
one of the new products, expects to raise between 2 billion and 3 billion yuan,
(USD326 m to USD489 m) for the new gold fund. Analysts see little reason why
this isn’t achievable, given the strong Asian demand for gold.
Many may be baffled why the Chinese, at this point in the
gold’s price cycle, are looking to launch two new
ETFs, let alone one.
Particularly as gold-backed ETFs in the West continue to see huge outflows.
The initial target of $489 m is nearly 4 times larger
than the initial holdings in the
SPDR gold trust, the world’s largest ETF based
in the US, yet analysts do not expect the Chinese gold-backed ETF to have such
an impact on the global gold price. This may be because Chinese investors are
known to want to own physical gold, yet similar products have proved popular in
India who have a similar sentiment to gold ownership.
Despite these new paper gold products, demand for
physical in China, remains strong. The gold market is expected to continue
booming this year, as vice-chairman of the China Gold Association told gold
mining conference attendees yesterday: “Chinese demand for gold will remain
robust because people are getting wealthier and investment choices are
limited…Per capita gold holdings in China are little more than 5 grams, compared
with the average 20 grams in developed countries, so there’s huge potential as
long as the economy is growing…”total demand this year is likely to be in the
range of 900 to 1,000 tonnes.”
They want physical gold as a store of wealth, in the face
of rising inflation and they are prepared to pay the price for it.
Premiums
At the beginning of June Bloomberg reported on premiums
jumping four-fold on the SGE as investors rushed to take immediate delivery of
gold bullion. “In the 12 months through April 12, before the rout, spot gold in
China traded at an average premium of $7.22 an ounce to the global price,
according to the Shanghai Gold Exchange. The premium averaged $33 an ounce from
mid-April through May.”
Premiums have been reported in the majority of Eastern
countries since April. Vietnam has seen 20% premiums thanks to strict government
gold controls.
Vietnam’s 20% however is nothing compared to those seen
in some stores in China. Ned Naylor-Leyland estimates that coin, bar and
jewellery shops have been selling at 24% premiums. A reduction (not removal) in
the premium saw a frenzied rush to buy gold in Shandong earlier this week.
These ever-present, and increasing premiums are leading
many to now speculate over the ‘two-tier’ gold market. Where prices appear to be
set in the paper gold market, ie COMEX, but it’s another story when it comes to
physical gold.
We all know which markets is ultimately boss – the
physical one.
In the graph below, courtesy of Koos Jansen, we can see
that the demand for physical tonnes to be delivered on the Shanghai Gold
Exchange is reaching global production levels.
Compared to COMEX, these levels of delivery are huge:
On COMEX total gold delivered didn’t even meet 10% of
global gold production, meanwhile delivery from SGE was nearly 100% of total
world gold mining production. Consider these figures now with those presented at
the beginning of this article, global physical gold demand is now likely to have
surpassed total supply for this year.
All driven by that ignored part of the world.
We have been exploring price discovery in other research
and the SGE is an area we intend to cover.
So for now let me leave you with the question, ‘should we
be ignoring the other gold market?’
I think not. Gold prices set in major Western markets may
be in retreat, but dampened demand is certainly not omnipresent across the
globe. The pace of increasing premiums in Asia mean physical gold prices are
booming, whilst physical gold cannot be delivered quick enough.
There is only so much time left before the paper gold
bugs can no longer keep the price down and geographically blinkered analysts
have to open their eyes.
