Gold: The Pawnshop Revolution

Includes: GDX, GDXJ, GLD, IAU, SLV
by: George Kesarios

I have a good friend who has a pawnshop in Athens (Greece). He is one of the oldest pawnshop owners in that part of Athens, and until several years ago he had no competition. Several years ago I asked him how the pawnshop model works. He said it's quite simple: "people come in my shop to show me their jewelry. I put it on the scale and give them 30%-40% of the value of the gold (NYSEARCA:GLD) or silver (NYSEARCA:SLV) in cash as a loan. If they don't come back to reclaim it (80% of the people don't), then I melt the gold or silver in bars and sell it at a profit". I was amazed!! How many businesses have 60% - 70 % gross margins?

Since then however things have changed. When I asked him several weeks ago how was business, he said terrible. He was down about 70% in volume with contracting margins. There is too much competition he said, "I have no idea how these other shops are making money on these margins" he told me.

I don't know what's going on in the U.S., but here in Europe pawnshops are sprouting up all over. Over the past 2-3 years pawnshops have opened in just about every corner of Greece. Even in the most isolated little town you will see these little pawnshops that have big flashy signs saying they buy gold and silver for top euro. In fact, the pawnshop business is doing so well, there are even pawnshop franchises! Italian and Dutch multinational pawnshop companies have also invaded the Greek market.

Like I said I don't have a sense of what is going on in the U.S., but from a little research I did I found that the pawnshop business is probably doing well in the U.S. also.

So the question is, if all these people all over the world are selling gold and silver at pawnshops, and the pawnshop owners sell it to bullion dealers, who is buying?

According to the World Gold Council in its most recent publication Gold Demand Trends, no one except central banks.

(Click to enlarge)

In fact, gold demand is down almost in all categories across the board, both on a yoy and qoq basis.

Now I don't know if the recent gold price action has anything to do with the pawn shop revolution, but I imagine it has played a role in gold's under-performance over the past 2 years or so.

I also think that as long as people have a need to sell gold and silver at pawn shops, this under-performance might continue. Also, pawn shops are not exactly a sign that things are going so great. Economic weakness is not bullish for gold or silver no matter what many gold bugs say (my opinion).

What I can say however, looking at the chart of gold, is that things are at the margin. If gold falls a bit more, I think we will see massive selling across the board from a wide range of investors, ranging from ETFs (NYSEARCA:IAU) to bullion funds to ordinary people shorting gold in the paper market, not to mention gold stocks (NYSEARCA:GDX) as well as junior miners (NYSEARCA:GDXJ).

(Click to enlarge)

The chart above is not exactly a bullish sign for gold. However, I will give the benefit of a doubt and say that gold might reverse from here (although I doubt it).

But please note that second bottom trend line. It marks $1.540 on the chart. In my opinion, if gold breaks below that level, watch out below.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.