The question I have been asked most over the last month is what is going on in gold? At US$711 per ounce as I write it has not performed as expected of a store of value at a time of financial uncertainty. Why not? This is a complex question where nobody has an adequate answer but I herewith accept the Minesite challenge to offer my opinions. Over the last couple of months, investors have been paying a premium of up to 10 per cent to get physical delivery of gold in the form of coins and kilo gold bars. European coin dealers have virtually no physical stock of gold coins left and are quoting six week waiting times for physical delivery, but then refuse to take deposits or to guarantee such delivery. Kitco advertisers and dealers on other mining websites declare that they cannot take orders for gold coins or small bars as they cannot make delivery.
By coincidence, official mints in several countries which were extraordinarily active minters for the millennium year 2000 are ‘recently unable’ to supply new gold coins, which is surprising given the evident strength of demand. But then mints need government permission to make coins of the realm and it is well known that Treasury officials around the world see gold accumulation as a readily publicised indictment of financial strategies. Ask Gordon Brown.
But why is this evident demand for gold not reflected on Comex, the dominant US commodity exchange? On Comex, spot gold at US$711 per ounce is down a remarkable 31 per cent from the US$1034 per ounce peak reached in the Ides of March. A remarkable decline for a commodity with a 3,000 year record as a store of value.
My contention is that we are looking at an abnormal dichotomy between a gold equilibrium price that would be set by untrammelled supply/demand forces and a spot gold price which is overly influenced by financial instruments and political considerations.
Commodity prices normally look ahead to anticipate emerging supply/demand trends. Pierre Lassonde and several senior gold producers argue that a gold price of over US$1,200 per ounce is needed to justify finance for new mine production, which implies that the replacement of depleting mine capacity is being deferred for several years. But at US$711 per ounce mines close and mine capacity depletes. Such capacity cannot be replaced until the gold price rises significantly and sustainably. This fundamentally bullish factor is not presently addressed and is apparently being deferred for future consideration.
Gold analysts see no material anomalies today in the regular demand categories of jewellery, industrial and dental, but coin demand is an exception as it appears to on hold. At least new mine supply can readily be tracked and is reasonably stable, albeit slightly down. And central bank sales which have supplemented mine supply for over 20 years can no longer be relied upon if their gold is already sold or leased. So far, so bullish.
But gold analysts are foxed by that wild card called ‘investment demand’, the swing factor, which has, counter-intuitively, sent the gold price down, and not up as expected. They have lost access to the reliable information sources which used to be available “for cross-checking, old boy” over a coffee after the gold fixes.
Many new bullion markets and exchanges associated with a host of alternative ‘banks’ now dominate the market and set the gold price. The gold fix still exists but is no longer the price setter, now that spot gold trades for 22 hours per day. These new entities assumed their role by persuading the traditional South African and emerging new world producers to contract their gold sales to them. This, in turn, facilitated the introduction of gold loans, options and various financial instruments based and then leveraged on mine production and existing above ground stocks. All of which multiplied the physical market more than tenfold.
While gold analysts can track supply and demand, they cannot second guess the young masters of the universe with their license to mix and match gold with paper and apparently slice and dice whatever customers on both sides of the equation want. And all at the same time! While such admirable protean qualities have over the past two decades brought in new mine production, gold has got further and further away from physical delivery and from reliable analysis.
One might dare suggest that gold is not an efficient market when prices set by financial instruments are not a true reflection of the forces of supply and demand. The warning lights are flashing now.
Sophisticated investors with cash available have tried unsuccessfully to get physical delivery of gold. Some are now are now buying on Comex and other markets offering instruments which claim to be gold backed. At least some of these investors are not traders and might well seek physical delivery and not be put off by the various hurdles set up by banks to discourage that course of action.
Investors with cash replacing investors on margin is a healthy thing, and over the last traumatic month, investors have been margin-called several times. This has been an unique time with both gold and equities hard hit simultaneously. While many equities have been illiquid, investors have been able to sell spot gold immediately and in quantity. The precious metal insurance strategy where gold is held to balance equity risk is not invalidated by the short term phenomenon which has been in evidence over the last month.
Investors temporarily short of instant cash or time to shift illiquid investments to meet successive margin calls do not determine a longer-term price trend. Their financiers have no time to be polite. The investors hit hardest recently have been the emerging market investors and leveraged funds who also bought gold. Each day we hear of another hedge fund entrepreneur packing up, folding his cards and leaving the casino. Asset management has no glamour in troubled times. Probably the new investors buying from such weak investors have a longer term perspective. Time will tell … and soon.
Now for some thoughts that come under the ‘what if’ heading - conjecture, not opinion. Comex warehouse gold bullion stocks are believed to stand at 2.1 million ounces, valued at under US$2 billion and are not sufficient if contract holders demand physical delivery. Sure it has never happened before, but we live in interesting times where many unexpected things in the financial world have happened that have never happened before.
What if Comex were to default? It could happen this year if holders of the December contract start asking for physical delivery from US Election week on, and this were to lead to a run on Comex. We have not seen such a dangerous situation in a commodity market since the Hunts almost cornered the silver market in 1980 and the then US administration waived the rules for contract settlement. Perhaps, as with the newly elected President Roosevelt, gold will be one of the first issues to be addressed by the new US administration.
But things have changed since 1933; changed again since the US dollar was detached from a fixed gold price in 1971; and commodity markets have changed just as dramatically since the Hunts were outmanoeuvred in 1980. Today these markets are much larger and more international and far more information is available. Today, for gold, well organised agitator investment groups such as GATA have files of circumstantial evidence suggesting gold market manipulation by the banks, and they are longing to have it put to the test.
Should Comex be allowed to default many would see this as confirmation that precious metal markets had been rigged to get the big banks off the hook at the cost of genuine investors. Far Eastern and European markets would benefit, gold would be ‘government confirmed’ as the ultimate store of value and, just maybe, all Comex market participants might be obliged to reconcile their positions in physical gold against paper contracts.
In this game of poker one side will be left with no clothes. This would be ugly, but it would certainly show US$711 per ounce to be a false price and we might soon see US$2,000 per ounce in the headlights. If we can still afford the car that is.
FML Price at posting:
2.1¢ Sentiment: ST Buy Disclosure: Held
(20min delay)