Gold Demand: The Great Disconnect Between Paper and Bullion

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So have we found a bottom in gold? Following last week’s plunge to around US$1320/oz, the gold price is now up to around US$1,470/oz, for a gain of US$150/oz. And the gold miners rallied strongly in the US on Wednesday night (as they are in Australia today), suggesting we may have seen an end to the capitulation selling.

And there was plenty of capitulating going on. On Tuesday, we asked a friend who works for a fund manager about a certain gold stock – mid pummelling. There were huge trading volumes going through the stock…the selling looked like pure capitulation. He responded that they were selling that day too. The reason? There is only so much pain you can take.

We could be wrong, but Tuesday and Wednesday seemed like the point of maximum pain for many gold stock owners. When you see the price fall day after day, it conditions you to think that it will keep falling. You think everyone must know something you don’t. No one wants to be the patsy at the table. You think that maybe your stocks will go bust and you’ll lose everything. So you sell, just for the psychological relief and to ease the pain. Fundamentals don’t really come into it.

What makes matters so acute for Australian gold miners is that they are amongst the highest cost producers in the world. When the price tanked last week, it rendered quite a few gold producers uneconomic. At such low gold prices, they were unprofitable. So if you thought low prices were here to stay, it made sense to dump the stocks.

But the recent rally could signal that the low price of recent weeks is an aberration. The high cost gold producers may just hang on and begin to generate profits as the price rebounds. For all the selling of these stocks in the past few weeks there was a whole lot of buying…the buyers clearly think low prices ARE an aberration.

The big meme in the gold market lately has been the apparent ‘disconnect’ between the paper price of gold and the physical price. All around the world we’ve heard reports of huge demand for physical gold brought about by the price collapse as determined in the gold futures market (aka, the paper gold price).

We consider this a very bullish development, but don’t be caught out by some of the extreme commentary that seems to suggest there’s little physical gold left in the world. For example, we’ve heard stories of huge premiums on certain coins as evidence of physical scarcity. But it’s just a function of the limited production capacity of mints around the world.

When you have demand over a couple of days that you normally see in a few months, of course mints and coin dealers will run out of inventory. So don’t be fooled into buying physical at a huge premium. Or as the Perth mint’s Bron Sucheki writes over at his Goldchat Blog, ‘Chill Out Dudes’.

Of far more interest to us is what’s happening at the big end of the gold market. This is where gold moves IN SIZE…and the moves are certainly mysterious.

For example, in just the past four days, COMEX gold inventory declined by 10%. Since the start of February inventories are down by more than 25%. That’s interesting news to say the least.

There are two types of gold inventory, ‘registered’ and ‘eligible’. Registered gold is available for delivery to the owner of a futures contract. Eligible gold is gold held by the bullions banks on behalf of clients for safekeeping.

Both levels are in decline. As of 24 April, there were 2.174 million ounces of registered gold and 5.817 million ounces of eligible gold. But eligible gold inventories have taken the brunt of the falls, suggesting clients no longer see the western bullions banks as safe guardians of their gold. Notably, JP Morgan’s vault of eligible gold is nearly empty, with just 141,500 ounces left.

Meanwhile, over at GLD, the world’s largest gold ETF, you’re seeing inventories fall too. Since the start of April, the trust has offloaded 127 tonnes of gold. The consensus view is that as the price falls, investors sell and gold leaves the trust.

But that’s not how it works. Investors sell shares in the trust, not the gold itself. Only ‘Authorised Participants’ (the bullion banks) can take gold from the trust, by redeeming baskets of shares.

Given the huge demand for physical gold recently, it is perhaps not surprising that bullion banks are using GLD inventory to augment supply. 127 tonnes of physical in a few weeks is huge. Where is it all going?

There’s a stark difference between the gold ETF, GLD, and the major silver ETF, SLV. Even though the silver price has crashed harder than gold, the SLV has actually ADDED tonnes to its inventory. So no selling at all, despite the price plunge.

You can twist this story any way you want. It could be bullish for silver because no one is selling physical (even though the ETF does not give you legal ownership of physical) or it could be bullish for gold because it’s a sign of strong physical demand for gold, not paper claims to it via a western bank run ETF.

Either way, it’s all an intriguing mystery. This precious metals story still has a long way to run. But last week’s price action was telling in that we think a few major global players showed their hand. It’s a stretch, and against historical precedence, but we think the patsy in all this could be the western bullion banks. When you hold a lot of paper and a dwindling supply of the real stuff, you’re certainly not coming from a position of strength.

Regards,
Greg Canavan
for The Daily Reckoning Australia

Join me on Google+
From the Archives…

Why Too Much Data Might Actually Protect Your Privacy
19-04-13 – Sam Volkering

This Gold Bug Ain’t for Turning!
18-04-13 – Bill Bonner

Music for Contrarian Ears
17-04-13 – Dan Denning

Bring on the Gold Correction
16-04-13 – Bill Bonner

Why China’s ‘Population Pagoda’ Could Mean Slower Growth for Australia
15-04-13 – Dan Denning

Greg Canavan
Greg Canavan is the Managing Editor of The Daily Reckoning and is the foremost authority for retail investors on value investing in Australia. He is a former head of Australasian Research for an Australian asset-management group and has been a regular guest on CNBC, Sky Business’s The Perrett Report and Lateline Business. Greg is also the editor of Crisis & Opportunity, an investment publication designed to help investors profit from companies and stocks that are undervalued on the market. To follow Greg's financial world view more closely you can subscribe to The Daily Reckoning for free here. If you’re already a Daily Reckoning subscriber, then we recommend you also join him on Google+. It's where he shares investment research, commentary and ideas that he can't always fit into his regular Daily Reckoning emails. For more on Greg go here.
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4 Comments on "Gold Demand: The Great Disconnect Between Paper and Bullion"

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justin king
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One of your best. Good workable info.——— Thanks, JK

shortchanged
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‘Paper’ gold , is just that, paper. Gold buyers do not want to store their gold in banks, why would they ? if banks have the ‘right’ to steal money from your accounts, would they take your gold as well?, your damn right they would, without a second thought. Banksters have no morals, if any of us ‘little people’, (their name for us by the way) did what they have done, we would be in the chokey in quick time. Not only ‘too big to fail’ but ‘too big to jail’. Slewie, I chose the nom de plume because I… Read more »
slewie the pi-rat
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there are different forms or fabrications of PMs and different marketing levels and channels and different currencies, futures, ETFs, options, swaps, leasing, reserve status and i think i need a nap after that… shortchanged: hi! if you want the lady of the lake to enjoy your golden nuggets, you might consider getting her attention with some golden earrings from a secret admirer… pretty linear stuff, huh? NOT! in slewienomics, recognized, standard PM coinage, from the local Mint, is “insurance”, world-wide: when paper is vapor, gold is to hold. and silver is insurance for people who enjoy mood swings. we’re very… Read more »
shortchanged
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G’day slewie, seems we both have had interesting times ,not dabbled in silver though, but your chart link says it might be about time. My ‘lady of the lake’ has enough baubles of her own, but I do enjoy surprising her so will take a punt (not the oxbridge kind, bit too old for that) and see what transpires. Must get some more gold coins, things financial are about to get rough. Have to admit its taking a bit longer to make the usual ‘modest gains’ but maybe a precursor to the ‘big one’. All my ‘junk silver leftovers’ are… Read more »
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