Gold Losing Its Shine as Supply Surges

While ETF demand for gold has surged this year (though it's now stalling), investment demand still accounts for less than 25% of the total. I've been bearish since the latest spike above $1,000 in mid February (and advocated Platinum as an alternative exposure with cyclical recovery upside, see Platinum: The Poor Man's Gold?). It's important to take a strictly agnostic view of markets and look at any asset on its supply/demand fundamentals; these have been deteriorating for gold. On March 6th I wrote regarding the dramatic outperformance of the dollar over gold:

The irony is that just about every goldbug was also a convinced dollar bear a year ago, and their emotionally charged analysis has proved utterly misconceived in a deleveraging global economy.

While many observers have concocted elaborate conspiracy theories to explain the relatively disappointing performance of the metal despite economic crisis and the historic Fed money printing initiative, the truth is far more mundane.

Most traditional emerging market importers have seen jewellery demand collapse to the remarkable extent that Turkey, the world's second biggest importer is now a net exporter of bullion scrap, and India, the biggest market, imported no gold in February and March. Economic distress in these countries has not only reduced demand, but created forced sellers. A similar pattern is evident in the Gulf states and across Asia, and the sheer volume of scrap gold now hitting the market far exceeds prospective IMF sales.

So far in 2009, scrap sales may well have exceeded global mine supply, and Asian prices are now at a discount to London rather that the traditional premium. Unless investment demand soars further from these levels, the downward pressure on prices could see gold trading well under $800 by early Summer. In 2008, gold again peaked in the first quarter, but jewellery demand bounced in late summer as prices sank toward the $700 level, but that was in a very different economic environment across the key importing markets.

This year, while the sheer volume of scrap exports is unsustainable, any rebound in demand would require a strong cyclical economic recovery in countries like Turkey and India. But that scenario undermines gold's recent investment role as a safe haven as other assets crumbled. I watch the EUR/JPY cross as a key measure of global risk appetite, and it is now at its best since late October, reflecting the recent rally across risk assets.Crucially, de-hedging by producers will be running at negligible levels in 2009, a function of the much reduced hedge book; there's only marginal interest in strategic hedging by producers.

While I expect inflation to pick up to mid single digits over the next few years in the US despite a very weak and erratic economic recovery, neither a dollar collapse nor hyperinflation are realistic prospects in the foreseeable future; China's bluff has been called in the recent debate about the dollar's role as de facto global reserve currency. However distorting to global investment flows, there is no obvious alternative in terms of liquidity and capital depth and certainly not gold; any commodity linked currency arrangement is essentially deflationary due to arbitrary supply constraints.

Overall, gold investors may be frustrated by another range-bound year, buffeted by the cross-currents of periodic spikes in investment demand set against fundamental demand destruction. There are plenty of other ways to hedge rising inflation in the context of a muted economic recovery and commodities like uranium, platinum and natural gas look more attractive medium-term prospects to me.

Disclosure: No positions

Comments

[LivininCDM:]

"It was amazing, therefore, when March 30, 2009 came and passed, and so many people stood for delivery, refusing to part with their long gold futures positions.

On Tuesday, March 31st, Deutsche Bank (DB) amazed everyone even more, by delivering a massive 850,000 ounces, or 8500 contracts worth of the yellow metal."

Yeah I would say supply has surged 850,000 ounces surged :) do you even read the other articles posted on seekingalpha?

Apr 08 01:22 AM

[Tom Szabo:]

This is a fairly good commentary but the author ignores the monetary reasons for gold's increasing attractiveness in the medium term as a safety valve against runaway fiscal policies that attempt to stave off a private credit implosion by means of exploding public debt. Neither the appearance of hyperinflation nor a high level of inflation is required for gold to march higher, only a growing consensus that monetary instability has greatly increased. At the same time, I would argue most hard assets are at equal if not greater risk of "fundamental demand destruction" compared to gold. I am bullish on uranium but on a 3-7 year time horizon. On gold, it is more like 1-5 years. I do agree with the author that from time to time gold will get pushed around by large forces and it could undergo severe corrections but that is the nature of gold.

There is no widespread inflationary consensus or general agreement on the extent of monetary instability today -- despite highly expansionary fiscal and central banking policies -- simply because competing factions of denialists and deflationists dilute any significant sway. When the deflation threat, however, is largely seen to be in the past (that day will come) but before inflation actually manifests itself in a general rise in prices, gold will do its trick and discount future price increases as it did in 1974. Importantly, the 1974 gold gold price at $200 was more or less where gold bottomed in 2001 ($250 -- close enough), which goes to show just how much of the future gold is capable of discounting.

A perfect logarithmic resonance would have gold reach $2000 this time but that level would barely account for the rate of inflation between 1974 and now, much less expected future inflation. Even so, $2000 gold is probably better than the level uranium, platinum, natural gas, etc. will achieve in the medium term.

Apr 08 06:02 AM

[mtt04:]

Gold is not an investment. It drives me nuts when people are pissed when it doesn't make money. IT IS MONEY.

It is insurance not a stock. When the specs get killed this round and the gold stocks plummet then you'll know that stocks are not gold.

Hard gold is something you hand to the kids when you die to protect them - not profit from. It has no debt, no derivatives, nor any obligations.

I am not a gold bug, just a guy who has a yard full of the stuff. Makes for great moguls in the winter by the way.

Apr 08 07:25 AM

[Vuke:]

Sean, jewellery buyers, importers and others are patiently waiting for you and other bears to unload. They know the floods of paper now being printed will take time to hit the street and are pleased to buy on dips.

They do have experience at this game....some 6,000 years of it.

Apr 08 07:41 AM

[Ian R. Camp...:]

I commented in a post today on SRPBlog.com with respect to ‘old’ jewelry sales in the U.S., and made a more general comment about the possible effect of ‘old’ jewelry sales world wide on the gold supply/demand equation. I have little doubt that it will have some effect. I am not nearly so optimistic as the author of this article on the current economic climate resulting in ‘mid-digit U.S. inflation over the next few years’, and so continue to see gold as a good ‘safe haven’ in the event of either hyperinflation or deeper recession/depression in the U.S. and, as a result, all or most other world economies.

Apr 08 07:51 AM

[IronMeteor:]

Right on the money. Don't underestimate the number of US citizens who are unloading scrap. I have to believe all those Gold4U etc... commercials are working or they wouldn't be on the air every 2 minutes. That must be a lot of gold they are collecting to pay off scrap sellers, overhead, and still make a profit.

It will end, but when? I have never read a good report on existing gold jewelry. Anyone have something?

Apr 09 01:35 AM

[Allan Frain:]

"China's bluff has been called in the recent debate about the dollar's role as de facto global reserve currency."

While China's talk and China's walk may not be in sync--this may be just a matter of time lag. While the Sword of Damoclese may not have fallen, it remains suspended.

Meanwhile, Helicopter Ben, in 2008/9, is earning the nickname attributed to his words in 2002.

Apr 09 09:05 AM