Gold: Heading for a Trainwreck Due to Oversupply?

There was a huge gold sector pump into the weekend that put the oil manipulators to shame as very low volume pumping followed very high volume selling that exhausted itself by mid-day. The fact of the matter is that gold did close below the 50 dma of $619 for the second day in a row against virtually no dollar movement.

The World Gold Council estimates there is currently a 52 ton surplus of gold, which makes sense since miners have now been ripping it out of the ground as fast as speculators would buy it for a full year now. This contrasts sharply with the Virtual Metals report which says there is only a 10 ton surplus. Virtual Metals is a research company employed by mining companies...

The big Kahuna in the gold market will be September 26th when an agreement that limits the amount of gold that can be sold by Central Banks expires. Just like any savvy investor, it will be hard to find a Central Bank that has been sitting on $20Bn worth of gold for many years and now sees a $40Bn value not to take a little off the table before the price evaporates on them. If they do not come to a new agreement (this is an oil country vs. mineral country kind of thing) we may see literally tons of metal being dumped on the markets in short order.

While you may hear figures that gold demand is up 12% from last year (more VM PR), the fact is that physical demand actually fell 24% by weight, it just cost a lot more per ounce! One big thing Virtual Metals ignores in its reports (because they only look at mined metal) is the supply of scrap gold, which rose 57% over last year as people melted down everything they could for $600 an ounce or more!

It is looking like the opening of the gold ETF, GLD, soaked up 109 tons in Q1 as speculators rushed in (they take physical possession of the gold) but ordered just 39 tons in Q2. Should investors leave the ETF they will be forced to dump gold on the open market just as the price is going down!

To see a train wreck in motion, take a look at these numbers from Canadian miner WDO, who just put out tepid earnings yesterday as 25% of the gold they produced went unsold for the quarter. Last year, demand was such that they had to draw 3,700 ounces out of reserves to cover sales of 15,800 ounces. This year, there was no trouble covering orders for just 8,700 ounces.

Nonetheless, as diligent subscribers to VM reports, they are going full steam ahead with additional production as "We are impressed with the strength in the gold market and believe it will continue to improve appreciably. It is certainly an opportune time to be bringing new production on stream."

As you can see from the financials, a doubling of operating costs is neatly masked by the $300 per ounce premium they have collected since last August and massive increases in the "value" of the reserves and mine assets make the company look like it is worth double last year's price. This is very similar to the logic the builders employed as they overpaid for land and overbuilt themselves into a crisis last year.

We need to watch the small, inefficient miners as they tend to suffer first, quickly followed by big trouble in the majors.

Comments

[J P]

You note the bias of one report, but ignore the bias of the other. The real question is what are the actual facts. An anecdote from one company is not going to tell us the trend. Gold has had a low price for over a decade, and is not even a quarter of the way to its previous high (inflation adjusted) and miners have not been opening new mines for 15 years or so, it doesn't make much sense to claim that suddenly there's an oversupply. Furthermore, scrap gold is a figure that is very hard to quantify.

Finally, what makes you think there is any gold in central bank vaults? Who knows when they ran out, or will run out, but after 20 years of dumping gold onto the market-- particularly when the price was already low- the ratio of central bank gold to fiat currency in circulation is at a low for all of recorded history.

That does not bode well for the age of fiat currencies.

[Philip Davis]

Yes I note the bias of the dominant report, all reports have a bias, it's just bad when the "official" report disguises that bias.

See my latest gold report at philstocks.blogspot.co.../ if you want to see the research behind it.

Mines haven't opened for 15 years because we are simply getting more gold out of existing mines. 15 years ago production was less than 1,700 tons, now it is 2,500. Had it not been for a 19% increase in investor demand for gold (mainly the 130 tons that went into the ETF this year) gold would have already fallen off the table.

The fact that scrap gold quantities are difficult to guage is the premise for VM throwing them out entirely. This is like pretending poverty doesn't exist because homeless people tend not to answer their mail.

Gold has had a pretty consistant value for 5,000 years and was $18 in 1833, moving up to $35 in 1964. From '64-74 gold flew up to $154 as the US went off standard and then, as you are well aware, spiked up in 1979-1980 during the first oil crisis.

Since then we have been in roughly the $350 range until last year.

So what is the real value of gold? Is it the 5,000 year chart reflecting unfettered international trade, or the current blip that is held together by commodity brokers and central bankers who have to make contracts with each other to "maintain price stability."

[J P]

Oh, its worse than I thought. You act as if $1 in 1833 is the same as $1 in 1964 (When we were still on the gold standard) and $1 now. In your world inflation doesn't even exist! Amazing!

Mines have not opened in recnet years because environmentalists and the price of gold made it untenable. Sure, some mines have increased production, but demand is growing faster, and demand growth is accelerating. You speculate as to what the source of the demand is, and you denigrate it as unsustainable-- but this is your speculation, not fact. More likely both historically and logically, is that gold has not increased in value so much as hte US Dollar has declined in value. Further, demand is coming from the fact that gold is a better asset to hold than dollars. Dollars are not trustworthy, while gold is an asset whose primary industrial purpose is to act as money.

Central bankers are not keeping the price of gold up, asinine statement that, as central bankers want to keep the price of their currencies up to cover up their inflating them. Think about it-- why do the central banks announce publically that they are selling gold? To depress the price. Why do they sell gold at hte bottom of the market and announce this publically? to depress the price.

Hell, I'm being a fool for even debating this with you. Alan Greenspan admitted in an interview and it was confirmed in FOMC meeting minutes that the federal reserve acts to manipulate the price of gold-- TO KEEP IT DOWN.

This is not up for debate, its a stone cold fact. And its the only thing that makes sense-- Central banks are not commodity traders "Taking a double off the table"... they are in the business of issuing fiat currency.

[Philip Davis]

I note the bias of the overused report, yes.

You can go here to verify the data: www.gold.org/value/sta...

Also, if gold accouted for 9% of the central bank reserves in 2004 at $250 an ounce,
www.gold.org/value/res...

is it your contention that it accounts for a lesser percentage at $600 an ounce?

If the central banks actually decide that they need to readjust their holdings (that September 26th date) to bring their gold reserves back down the the value percentage level they have held for 20 years, then we could see, conservatively, a 30% sell-off of the CB's combined 32,000 ton supply.

As total gloabl production is less than 2,000 tons, I'm sure you see how this would be bad!

You'd better hope that the CBs place have a lot less faith in gold holding its value than you do...

[J P]

You're assuming that central banks have not been selling any gold between 2004 and 2006, while talking about possible changes to the agreement whiereby central banks sell gold! The "percentage of assets" is an irrelevant figure, because its measured in fiat currency. The questions is, how many ounces do they have.

The reality is, you do not know. The statistics you are counting on count both physical gold and "gold notes" that is, gold that has been sold already, or "leased". Its not real gold, and thus it cannot be sold onto the market without creating an equal demand to find the gold (on the open market) to satisfy the note.

Please visit gata.org for a thurough investigation of the state of gold in central bank vaults.

The name of the game is-- sell gold short so that inflation does not look as bad. You've fallen for their propaganda, masquarading as statistics.

[Shad Bell]

Phil,

Can you tell me at what time of year jewelry demand is at its highest? Also is it possible the dollar is losing its grip as the world's reserve currency?

Like you I'm short gold stocks, but admittedly questions like this are starting to keep me awake at night.

[J P]

Shad--

Being short gold stocks is a dangerous position to be in. What do you expect to happen? If you opened a short when gold was ahead of itself in the mid $700 then great, take your profits. But now? Look at the seasonal price history of gold. Its generally down in the summer, and up dramatically in the fall. Gold stocks are generally companies located in canada, and in canada the brokers take the summer off, so volume is down, prices are down, etc. Then in the fall, they come back and buy back in.

Consider buying put options on a major minor if you want to go short gold...at least then the worst you can do is lose %100 of your investment, instead of your shirt. Look at the price action of the positions you're short last fall... they were "Cheap" in september and quite dear in December.

The US is losing its place as the worldd reserve currency. Russia, India, China, South Korea, Singapore, Malasia, The UAE, Saudi Arabia, Iran, Syria, Pakistan, Turkey are all countries that have announced their intentions to diverisfy out of dollars and into gold. Phil may think that Russia, India and China are "small countries" hopefulyl you don't.

Also, why hold dollars when there is the Euro and the Yuan now? Both of these are the currencies of the future, the US government is acting irresponsibly and everyone knows it.

The US is a debtor nation- both internally and externally, our credit rating is effectively going down and the dollar is declining in value so holding large quantities of dollars is a bad idea.

What's the alternative? Silver? Maybe, Other currencies? Sure, the Euro is going to be more popular. Gold? Yes, historically this is the primary purpose and use of gold, and these countries have already started buying.

[Philip Davis]

Jewlery demand is highest right now, wedding season in Asia through Decemeber but much more so for the wedding season than Christmas.

======================...

JP, there are sites that will "prove" anything you want but let's just look at the facts.

Production is exceeding demand.

Central Banks hedge currencies and commodities all the time, it would defy logic to think that they won't take a double off the table.

While small countries may up their gold holdings to legitimize their currencies, major countries like China have no intention of "legitimizing&quo... the Yuan by exchanging it for shiny bits of metal, not when they can buy perfectly good oil companies (or make deals for Venezualan oil) with it. When they figure out how to get gold to give you 1,000 miles a gallon perhaps it will change but right now major countries are putting their money into oil and water rescources, not burying in vaults like it was the 1800s.

What is the logic to the US holding gold? In the event of a global collapse that wipes out the United States of Amercia and invalidates our currency at least we can open up Fort Knox and trade Canada for some food? Times have changed and, as Nixon said in 1972 - "Real men don't hoard gold!"

[J P]

You're welcome to start looking at the facts any time you like.

First off, Central banks don't have a double to take off of the table. That's nonsense. They aren't buying gold onthe open market as a hedge against their currencies. They are SELLING gold on the open market because they know the price of gold when priced in their currency indicates the level of inflation in the country. This is why the price of gold was in a bull market in the US between 2000 and 2003, but not when priced in euros, etc.

China has announced its intention to increase their holdings of gold. Your statements indicate a profound ignorance of the nature of money, and actually, the economic concept of inflation. The purpose of China increasing its gold holdings is NOT to get rid of Yuan and hold "shiny bits of metal" (using that phrase is proof enough that you don't know what you're talking about- this is the kind of thing that socialists tend to say when they misrepresent keynsian economics. Here's a nixon quote for you: "We're all kenysians now!"

What was I talking about? Oh, yes the facts of which you are ignorant-- China will not be buying gold with Yuan, they will be buying it with Dollars. Where do you thin our trade deficit goes when we import chinese goods and don't export nearly as much to them? They are holding dollars and ratheer than hold dollars that are increasingly becomming worthless because of US inflation-- they are dumping those dollars to buy gold. Of course they are also buying oil companies, gold and silver mines, water, and every other resource they can get their hands on. But they hold about a trillion dollars in devaluing paper, and buying gold lets them store that value in an asset that will not devalue in the interim before they can use it.

The US government shouldn't hold gold because they can never hold enough to back up the dollars they have printed. However, when the US dollar fails-- as all fiat currencies do, and the American currency has three times already in US history-- those who hold gold will be able to b uy canadian wheat, oil, water and chinese manufactured goods.

What's the alternative to holding gold? Holding paper, and if you hold paper currency, you're losing %15 of your wealth each year. (Depending on current inflation which is around %8 as measured by the CPI, but has been as high as %13 in recent years as measured by M3 before they started printing it-- and the reconciliation of the inflation that's occured since 1980 but that was not seen because the USD was the reserve asset of most international banks.)

We've been exporting dollars for decades and as a result have been able to hide the effects of inflation. Now its gotten to the point where the people holding all our dollars have had enough, and CHINA, INDIA and other major nations are moving out of the US Dollar. When those dollars come home to roost, we will have extremely high effective inflation (Decades of inflation realized all at once) or possibly a self-feeding hyperinflation.

The disdain you showed in your last message is the disdain of a fool who belittles that which he is ignorant of. You should be embarassed, not spewing insults.

[Philip Davis]

I am not trying to insult you. Obviously you have a great passion for gold as is obvious from the shear volume of these messages you post to get your point across.

This is not a research paper so I am not going to attempt to refute your statements. I am a simple trader who is making a call on gold as beign overpriced at $640 (only its not $640 anymore is it?) an ounce.

I will not be short on gold at $400 nor am I likely to be short on gold at $500 but I do believe we are in for a correction at this level.

China may increase their reserves from the 1.2% they currently hold in gold but what you should be a lot more concerned about is the US reducing the 80% they now hold since gold has climbed to $600
www.financialsense.com...

Of the 140,000 tons of gold that have been mined in recorded history, the US has 8,139 (about $160Bn) in storage. This is an accepted fact but if they are engaged in a massive cover-up as you suggest then there really is no hope.
www.galmarley.com/FAQs...

All the other central bankers combined hold just 52,000 tons. Perhaps you are confused because "the Treasury, pursuant to 31 United States Code 5117 (b), values its gold stock at $42.2222 per fine troy ounce and issues gold certificates to the Federal Reserve at the same rate against all gold held."
www.fms.treas.gov/bull...

That may lead you to underestimate US holdings somewhat...

[Philip Davis]

I'm sorry if you take criticism of your position as "disdain." Were I going for a doctorate I would certainly bombard you with facts to support my position but I'm just a simple trader at heart.

So rather than get into an argument with you which I can never win, I simply, very publicly, took a short position on Newmont Mining yesterday, despite oil shocks, hurricanes, Iran, Lebanon, the criminal cover-up of the central banks and the massive Chinese buying so feel free to wish me into bankruptcy next week while I fantasize about taking a very nice vacation if gold drops back to $600!

I hope your position goes well too.

[Shad Bell]

J P, actually I am part of an investment club of around 50 members. Just as Phil is advising through his articles we are shorting gold stocks at this time, so I’m certainly not alone in this camp. We are presently entering our positions.

Phil, I understand you fall into the “short” category as well, but I’m questioning your logic on the central banks being able to depress the gold price. Our group reasoning for a drop in the gold price is geopolitically oriented. We expect tensions will be forced to calm down rather than escalate and this will affect the gold price downwards. We see a $50 war premium in the price.

You mention value then we must take history into consideration and indisputably gold is recognized as the currency of last resort. Today the dollar is the world’s reserve currency however; our huge trade deficit and extremely high debt levels (8.5 trillion) may be affecting its status. If we were to sell all the worlds’ known gold at today’s prices we would still only generate 1.7 trillion dollars.

Any doubts about US creditworthiness could cause foreigners who have been supporting us to stop or slow down their purchase of US debt, actually it could have the inverse effect in which they start to dump their dollars in lieu of diversification. I believe there are rumblings coming from top brass in Russia and China on this very topic. The only two other paper currencies that are large enough to function as the world’s reserve currency are the euro and the yen, but neither are attractive alternatives to the dollar. With its inefficient, tax heavy, socialistic economies the euro is a doubtful successor and with a decade and a half of deflation on its balance sheet the yen is hardly the answer. So what does that leave us?

Is it possible that we are being set up and brainwashed into trusting that it’s the central banks that are going to be the cause of supply when in reality maybe they will be or are the foundation of demand of gold. I mean let’s not forget for a “barbarous relic” only a few years back gold was at $250, so who the heck has been accumulating over the years?

Think of it this way, let’s say you are in the market to buy a house you found in a favorite location and ten of your co workers are looking for the same kind of house in the same location, are you going to disclose your discovery before your offer is accepted?

I did a little research and found that in the 50’s the percentage of reserves held in gold by the largest central banks was over 86% and yet today it’s only around 14%. Without a rock-solid paper currency for these banks to rely on, is it possible that the central banks are gold’s future buyers? I am thinking about this now and after applying some basic math to the possibility of this scenario unfolding, I discovered that just a small increase in the banks holdings could have a weighty impact on the price of gold.

[ray lopez]

One thing for AU shorts to consider: why is gold volatility up when volatility in all financial markets is down? Go here: BIS Papers No 29 The recent behaviour of financial market volatility Monetary and Economic Department August 2006 Fabio Panetta (Chair) (excellent paper giving reasons why volatility is down the last decade, aka "The Great Moderation")

Could it be that volatility is coming back, reverting to the mean with a vengence?

That said, I was long in AU since 2003 but now have reduced my position by 25% (taking some profits). But I remain a gold bug.

The dollar will fall, AU will rise, but I don't expect the US government to capitulate easily on the dollar (which allows 'deficits without tears'), anymore than the Japanese government does in keeping the Yen weak. Both these countries have agendas. But the truth will out. Like Newport Mining said last year: Nov.05: Newmont Says Gold to Rise Above $1,000 as Asian Demand Outpaces Production

And central bankers be damned--they cannot stem this flood anymore than the Dutch schoolboy with his finger in the dyke.

[Philip Davis]

Shad,

I am only short on gold in that I feel that we have gotten a bit ahead of ourselves. I will be taking profits off the table at $600 and probably all out at $550 and considering reentering long positions, especially on the miners, who tend to overreact to mild price fluctuations.

I never suggested the US Treasury was going to sell their gold (roughly 12% of all the gold that exists in CB storage). They only value their gold at $42 per ounce anyway!

The US, which I belive has about 8,200 tons of gold in storage (assuming there is no huge scandal covering up a shortfall), in just the Federal Reserve in NY and this is the only batch that is actively managed. No one knows how much the US has tucked away in other facilities like Fort Knox (I know, if any, according to gold bugs!).

www.globalethics.org/n...

I am more concerned about smaller foreign central banks, in countries where the GNP is perhaps $200Bn and they had 10% of their holdings in gold in 2004 and now find they have 20%. Should that central bank make a decision (even based on their faith in gold maintaining it's current value) that 15% reserve would be adequate, then suddenly 260 tons of gold may find its way to the market ($5B).

Since most countries of note have some kind of gold reserve, the real gamble is that none of those countries will do any significant gold selling if they percieve we have reached a market top. Last year we saw some wild swings in commodity pricing from Chinese hedging, do we really think gold will be immune?

I'm quite sure the Yen is a long way from being a trade up from the dollar (and you know I am no great fan of US monetary policy) and Europe is just too darn close to all the crazy people - hence the dollar's quick jumps every time a new nuclear terror is announced.

60% of the above groud gold in the world is held by people, not Central Banks. If your figures are correct and the CBs decide to move back to 86% gold reserves, even if it were physically possible, you would be talking about gold at $3,500 per ounce.

Since the US currently has $1.7T in gold anyway, this would neatly solve our national debt issue! Nice as that would be, I somehow doubt it is the mission of the other CBs to convert all 70% of their currency float to metal in order to further enrich the United States as well as randomly enrich billions of people who would suddenly find themselves with trinkets that are worth thousands of dollars.

The fantasy of paper money needs to be defended because the world has long outgrown the ability to back currency with hard assets.

[Philip Davis]

Opps, not $1.7T in US gold, $170Bn - big difference!

[J P]

There's a big difference between predicting that gold will hist $600 when its at $640, or $614, and calling for a "Trainwreck"... In no way is $600 a trainwreck.

What you were seemingly saying is that the bull market in gold is over. This is very different. I won't debate where gold will go in the short term because I cannot predict it-- but I will say if gold goes to $600 or $550 even, it WON'T be because of central bank dishording-- even if your theory was correct, dishording is not what causes such small moves.

I think your ability to predice the direction of gold would improve if you understood more about the market for gold and the players in it, and so I suggest you read the GATA website. Frankly, to speak disdainfully about it and to publically make calls on gold is to reject one of the fundamantal sources of information about the gold market, they've already done much research on the subject.

Finally, on the subject of US gold holdings, you accuse me of the fundamental error you are making- that of confusing paper with gold. I am not undersestimateing US gold holdings, I simply went an pulled the annual reports of the Federal Reserve branches and looked at their holdings. They are not holding US Gold certificates, tehy are holding gold liability certificates-- that is to say, the leased the gold out years ago. Its not a "massive coverup" because the information is there in the annual reports for anyone to look at, if they will understand.

www.stlouisfed.org/pub...
Page 60.
$327M in gold "certificates&quo... vs. $24B in outstanding currency. You assume these certificates are pricing gold at $42, and are US government certificates with gold backed at fort knox... but it does not say that, and this is not the case according to statements by Mr. Greenspan. Its not a cover up if you announce it publically and people turn a blind eye.

[Philip Davis]

Ah JP, see I don't write the headlines - please take that up with the Editors as this happens once in a while.

That link is for the St. Louis Fed, I don't think they hold gold themselves, I'm not sure if anyone but NY has actual gold but I just checked (you made me curious) and they do, in fact, have 9,000 tons of it in NY and there is even a tour so you can go see for yourself.

You sound smart so I'm sure you realize GATA has an agenda so all the information they gather is, of course, going to prove the point of the Gold Anti-Trust Action Committe...

I think their video says it all:
www.gata.org/node/20

[J P]

"but NY has actual gold but I just checked (you made me curious) and they do, in fact, have 9,000 tons of it in NY and there is even a tour so you can go see for yourself."

What keeps me responding is your dishonesty and misrepresentation. For instance, you say the above as if that 9,000 tons is US gold, it is not, it is owned by foriegn interests.

"You sound smart so I'm sure you realize GATA has an agenda so all the information they gather is, of course, going to prove the point of the Gold Anti-Trust Action Committe..."

Which is completely asinine in the face of the shear volume of carefully selected irrelevant facts you have cited here, or misrepresented here. The big difference is that GATA has evidence showing its theory.

Worse, when you present "facts" you're dishonest about it. You cite statistics as if they respond to a point when in fact that are completely irrelevant-- the Vault at the Federal Reserve in New York holding 9,000 tonnes of foriegn gold is completley irrelevant to the FACT that the annual report of the St. Louis Federal Reserve which I cited, shows that they hold zero gold, only gold certificates. Paper.

Unlike GATA, you are being dishonest with the "Facts" you cite, by snidely citing made up (eg the claim that hte US has %80 of the gold) or irrelevant "Facts" to support your position, while ignoring the real points I have made.

At first I thought you had just been mislead, or misunderstood and that you could be corrected. Now I understand that whether that is the case or not, you are a fundamentally dishonest person, and thus not worth wasting time arguing with.

I'm done here.