Not All Gold Demand Is Equal: WGC Report Shows Serious Upcoming Supply Crunch

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Includes: CEF, GG, GLD, GOLD, PHYS
by: Hebba Investments

Each quarter the World Gold Council (WGC) releases its "Gold Demand Trends" report, which examines trends by sector and geography. This report offers investors a good opportunity to take a look at one of the premier publications on the gold market, and though some investors have questions about the quality of WGC's numbers, it is one of the few reports available on worldwide gold supply and demand.

Usually this report is only tracked by some of the most ardent followers of the gold market (it does make some media headlines in the gold industry), but in this quarter's report we believe there is something very interesting that all gold investors should know.

We are not going to cover this report in detail, but rather, will focus on what we believe is the most important thing in the report for gold investors - that is the gold demand overview.

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Again, we are not going to get into the validity of these numbers (we do have some questions) but we will assume they are ballpark figures and are relatively correct since they do make sense.

As investors can see, according to the WGC, gold demand dropped from 974.6 tonnes in Q2FY12 to 856.3 tonnes in Q2FY13. The drop was primarily due to a decline in ETF gold demand and Central Bank demand, while jewelry and bar and coin demand had large increases during the quarter.

Let us now take a look at the WGC report for Q1FY13 demand to get more than just a second quarter snapshot.

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As investors can see, the trend has been the same for both quarter of FY2013, with ETF demand going negative to the tune of 579.1 tonnes, while coin and bar demand increased by 885.3 tonnes.

What This Means for Gold Investors

If an investor looks at this report they may wonder what the significance is. Bar and coin demand is up, while ETF demand is negative. They cancel each other out - so what is the big deal? That's where an understanding of the type of demand comes to play. All demand is not equal, and ETF demand is very different than bar and coin demand.

ETF's and other similar products are very finicky in their demand. They can vary tremendously from quarter-to-quarter - one quarter they are buying gold in huge amounts, while the next quarter they are selling it. These are very weak hands,

Bar and coin investors are the complete opposite. They purchase gold with a much longer term horizon, and are not going to be selling for a 10 or 20% gain. Investors do not purchase kilo-bars, American Gold Eagles, Kruggerands, Canadian Maple Leafs, etc because they want to make some quick money in the gold market - they buy to hold them for much higher prices or simply to keep their wealth in alternate forms. These investors are very strong hands and will not be selling except at far higher prices.

After understanding this, an investor can truly see that we may have some serious supply issues in the future if ETF gold sales stop. After all, in the first half of the year ETFs sold a stunning 580 tonnes of gold (over 25% of annual gold mine supply) which kept the gold market supplied with ETF gold as other demand rose due to the fall in the gold price. If this gold was not unloaded by the ETF's, the market would have been short by this amount of gold which would have led to a much higher gold price. We are now beginning to see ETF gold outflows ending - if physical demand keeps up anywhere near to what it was in the first half of the year there may be trouble.

If the argument was simply that the end of ETF gold sales would be bullish for the gold market - it would be a strong argument. But if we add to that argument the fact that in 2011 and 2012 ETFs were net BUYERS of gold (they actually increased demand), what would now happen to the supply and demand picture if ETFs started buying gold again?

As we stated before those investors that bought coins and bars would not be quick to sell their gold, so ETFs would have to look elsewhere for gold. They would not find that much from newly mined gold sources either because, as we've covered before, gold mine supply is dropping as miners cut back their production due to lower gold prices and structural issues.

Where is this gold going to come from?

This is a very bullish scenario for investors and it should put a lot of fear into those shorting gold because they are following the trend. Investors interested in taking advantage of this scenario should consider buying physical gold and the gold ETFs (GLD, CEF, and PHYS). Gold miners offer good exposure to the gold price (though a lot more risk) and they may want to consider low-cost producers such as Randgold (NASDAQ:GOLD), Goldcorp (NYSE:GG), and Alamos Gold (NYSE:AGI).

Keep an eye on ETF inventory numbers because if they start buying gold again then the gold market will face some serious supply issues. Investors should just ask themselves where these ETFs will get their gold from. We do not know. What we do know is that we want to own gold before the ETFs and the gold shorts realize that there are serious questions in terms of the supply picture.

Disclosure: I am long SGOL, AGI, GG, RIC, SIVR, GOLD. 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.