May 19, 2012
The latest numbers published by the World Gold Council reveal that there is a sea-change happening in the gold market. It's no secret that central banks have been buying, intermittently, gold and adding to their official reserves. The first quarter numbers showed clearly that gold demand is rising in the East faster than it is in the West and this has helped push the price higher.
The trend looks to be just beginning.
Recent weakness in gold (AMEX:GLD) has been at odds with its role as an inflation hedge, a $267 drop from peak to May 16th's bottom near $1525 per ounce, sparking talk of intervention and manipulation of the price from traders to fund managers and even members of the media. But, the data just released by the World Gold Council made it clear that production was up 5% year over year and overall demand was down slightly for the second quarter in a row. Whether that was the driver or not is speculation but at some point the losses in other markets begat margin-related selling in gold helping things along.
The WGC estimates that private gold holdings in Turkey (AMEX:TUR) are more than 5000 tons, one of the highest per capita hoards in the world. Demand rose 32.6% over 2010 to 143 tons but that is only 57% of the pre-Lehman Brothers crisis levels, which routinely saw 200+ ton demand levels. The global recession quartered Turkey's gold demand as disposable income became scarce.
In 2011, for the first time, investment demand outstripped jewelry demand by 9 tons. Their central bank added 79.3 tons, raising reserves to 195 tons by the end of 2011. Efforts by the government to bring some of that private gold into the banking system have seen their reserves rise to 209.6 tons by May, representing more than 12% of Turkey’s reserves. Clearly both the people and the government of Turkey are worried about the future.
This is a growing trend where gold demand is rising all across Asia: from the Baltic with countries like Russia, Kazakhstan and Turkey all adding to their official reserves to Southeast Asia where investment demand dominates in places like Vietnam and Thailand.
Central banks make these moves for different reasons, but the underlying reason is they are diversifying away from the U.S. Dollar as their primary reserve currency to protect themselves from the stresses in the U.S. and European banking systems. Emerging markets are particularly susceptible to exported inflation from the Federal Reserve’s actions. The gold flow data clearly shows them reacting to protect themselves.
China Surpasses India
China's (AMEX:FXI) demand rose 10% in the first quarter year over year. This includes the 149 tons imported through Hong Kong in the first quarter, an annualized rate that continues to rise, which is currently 596 tons. In March, more gold flowed through Hong Kong on its way to China than did in January and February combined. That is an annualized rate of 912 tons for the March. That is a staggeringly large number.
Why the sudden increase? Remember that $267 drop I mentioned earlier? Reports of massive physical flows that were floating around at the time can now be confirmed. Let’s not forget the looming U.S. and E.U. sanctions against anyone still trading with Iran, namely Iran, Turkey and Russia, who have been, by far, the biggest buyers of gold in the past fifteen months.
Does anyone reading this want to take the over/under on what the number will be for April when the price declines in Gold and rhetoric over trading gold for Iranian oil began in earnest?
This is a natural outcome of a market that is trading at odds with its fundamentals. Monetary and sovereign debt stress should be putting a bid under gold, not causing it to be sold. Unfortunately, markets can trade irrationally for any number of reasons for far longer than we can understand why it happens. The disconnect between the paper and physical markets could not be clearer when one looks at the fundamentals and yet both Gold and Silver (AMEX:SLV) have been in brutal sell-offs for the past 10 weeks. This move started after the Federal Reserve announced there was no need for more Quantitative Easing in the near term on February 29th.
Earlier in the week I analyzed the Fed's behavior and concluded that Ben Bernanke is attempting to implement his sterilization of the original balance sheet expansion dating back to 2008 but that the market cannot handle the Fed backing out of the credit markets yet. Inflation sentiment is rising and gold should be with it but it hasn’t responded. While I find the endless top and bottom calling by traders and bloggers to be of little to no value, that divergence on May 16th had become unsustainable in the same way that JPMorgan's (NYSE:JPM) CIO trade had become and the gold bulls finally made a big enough statement to put a floor under the price.
At this point gold is telling us that the people on my side of the world believe gold to be grossly undervalued in the futures market and will continue to sit back and catch gold bars as they fall into their laps at discount prices.
It’s also telling us that there is something fundamentally wrong with the path we’re on.