Gold's Big Secret - No One's Actually Buying

The little-known state of the gold market right now...

YOU WON'T read this in the financial pages, nor elsewhere online. But this autumn's gold rush has in fact has been no such thing to date.

No one's actually Buying Gold right now. Not the physical metal (and not the exchange-traded trusts either), not at anything like the rate they were buying a year or six months ago. Instead, this rush differs in kind from the surge of autumn '07 or the panic of late '08. Because it's a rush almost solely in leverage.

Hedge funds and prop desks have been buying Gold Futures and options with virtually free finance. Hence the surge in stocks, bonds and commodities too, of course. Because anything traded on margin looks a safe bet when finance costs you 1% or less per year. And especially when your major funding currency – the long mighty but now tired and emotional Dollar – is universally condemned to fall further.

John Hathaway of Tocqueville Asset Management called a similar rush into gold a case of mistaken identity back in late 2006. "Perhaps hundreds of billions of new institutional money has flowed into the commodity sector," he wrote. "Gold was caught in the cross fire..."

Here in late 2009, however, the institutional money is borrowed, not cash, and the prime brokers (formerly known as investment banks) are doing the lending with government-guaranteed finance. Since the end of August, open interest in Comex gold contracts has swollen by more than one third...the fastest jump since late 2007, back when the Fed began slashing rates, oil vaulted towards $150 per barrel, and the run on the banks really got started.

And whatever you think about gold-industry players wantonly shorting the market, no one forces speculative funds to take the other side of those trades. Given the jump in prices – up 11% since the start of Sept. – you can see who's making the running.

Now we've got zero per cent rates and outright money printing by the big four central banks (a.k.a. "quantitative" and "credit" easing at the Fed, Bank of Japan, ECB and Bank of England). But private investors don't feel the same fear as when their bank accounts threatened to vanish – and their retirement savings dumped half their value – this time last year.

Yes, the doctors and dentists are in ("Fill 'em...drill 'em" as an options broker once put it to me), but it's the large speculators – meaning hedge funds and money managers – who are sitting on a record net long position, holding well over nine bullish bets for every short contract they've got.

New routes to cost-effective gold ownership continue to grow (well, they do here at BullionVault, with our users adding 38% to their stock of physical gold so far this year. Client property doubled over the first nine months of '08.) But overall, retail investment in physical metal has weakened sharply from the record demand of Sept. last year to March 2009.

London's GFMS consultancy says investment off-take from the physical market fell by two-thirds in the second quarter from Q1, and everything points to a further sharp drop in Q3. Coin-dealer mark ups on bullion pieces have fallen in half on average, back to 5% above spot from the genuine "gold rush" of this time last year. No one's saying they're sold out today. Big-name dealers were offering 3-week delays and worse in Oct. '08. The best that promoters can say now is "Plenty of stock available..."

Collectible coins face the same hesitation. "Normally aggressive buyers were guarded in their buying," reports Numismaster's Harry Miller from last week's CoinFest convention. "While not stating it openly, I think many feel the premiums on numismatic issues are outdone at current levels, and bullion itself needs a rest."

Amongst the exchange-traded trust funds, the same story – no matter what the minor trusts might have you believe in their PR campaigns. The huge SPDR gold trust, now holding more gold than all but the top five central bank hoards worldwide, swelled 60% in the six months to end-March. It's added barely 8% since. London's incumbent leader, GBS, has shrunk from its April peak. Overall, the total ETF positions that the World Gold Council tracks added barely 2.2% between July and end-Sept.

"Thing is," as a professional wholesale dealer here in London's bullion market told me today, "the ETFs still don't show any signs of shrinking when the price takes a dip. They're as sticky as ever. But no, overall, physical flows at the moment are nowhere as strong as they were. The action's very much in the futures."

Conclusions? For the fees we charge at BullionVault? That would be asking too much. But until a larger number of savers spot the trouble in 0% rates and central-bank money creation, it's big speculators using borrowed money who look set to keep making the running in prices.

Disclosure: Long physical gold

Comments

[sdavid0419:]

Your head line is mostly accurate. Every time I go to my bullion dealer I wait in line with the sellers until I get my chance to buy. Some people think I am a nobody so your headline would be correct with "NOONE". Actually, I like it this way as I have been a contrarian most of my life. My forefathers told me to buy when everyone else is selling and sell when everyone else is buying. This advise has worked well for me. By the time the true inflation numbers get published and the hoards flock in to buy I will have plenty of inventory of which to sell. One sad note though is that most of the sellers in line with me are people that have to sell to meet their daily obligations. As to the institutions and their leveraged trades I hope they are on the correct side because if they need my gold to cover their shorts they will pay dearly for it!!!!!!

Oct 27 10:11 AM

[Screwloose:]

Adrian

Very valuable piece of analysis - thanks.

What's you view on the state of LBMA physical stocks? There have been various strange occurrences of late that could be explained as hiccups in the supply chain - have you heard of anything similar?

(I see Da Boyz are busy bashing today - anyone would think it's options expiry day.......)

Oct 27 10:23 AM

[Mad Hedge F...:]

qpo In view of today’s dreadful market performance yesterday, I am repeating my GLOBAL RISK ALERT issued on October 14. Every asset class, including stocks, Treasury bonds, currencies, commodities, and precious metals, got slaughtered across the board today. The liquidity surge may be taking a pause. Keep in mind that if you are running big longs here, you are swimming at the deep end of the pool.When everything is working, and my portfolio is firing on all 12 cylinders, I pinch myself and ask “Is this real? What can go wrong?” I’m reminded of the slave whose task it was to remind conquering Roman generals “All glory is fleeting.” Virtually all of my recommended core longs in gold, silver, Canadian, New Zealand, and Australian dollars, Brazil, Russia, India, South Korea, Taiwan, Vietnam, and junk bonds are at or near highs for the year. I called the bottom in Natural Gas within 40 cents, and mercifully baled on my one short in US government bonds, the TBT. What we are seeing is a global surge in liquidity as cash emerges from the bomb shelter, squints at the day light, and then rushes to buy the first thing it can find. Everything is going up, regardless of fundamentals. It is the proverbial tide that is lifting all boats. You can make a lot of money in these conditions, but there is no way of knowing if this will last for one week, or another year. But they can go on much longer than you think. In the last two liquidity driven markets I traded, Japan in the eighties and NASDAQ in the nineties, fundamental analysts railed against the tide for years, claiming that stocks were overvalued, each call getting their office moved ever closer to the elevator and men’s bathroom. When someone finally did throw the switch on these markets, it got dark amazingly fast. Tokyo went out at an all time high on the last day of 1989, and then dropped a staggering 45% in January. NASDAQ plunged just as fast from its 2000 top. The one thing we can all be certain about is that the survivors have vastly improved their risk control after our recent crash. Make hay while the sun shines, but keep your finger hovering over that mouse. The level of risk now is definitely much higher than it was in March. When the next real downturn starts, it could resemble a flash fire in a movie theater.

Oct 27 10:58 AM

[sofarpretty...:]

MadHedge,

I hope that someday you'll master the "enter" key so that you can separate your writing into paragraphs.

In case you haven't noticed, newspapers present their articles in short paragraphs--because long paragraphs are difficult to read when working with narrow column widths. Your posts are way too difficult to wade through in their present form. I'm sure that many just can't be bothered, myself included.

Oct 27 02:58 PM

[Tom Szabo:]

Excellent overview of short-term fundamentals but one thing missing is the answer to the question, what happens if the speculators turn tail? Will physical buying show up in all possible scenarios (the so-called Beijing Put) or are there some possibilities where basically there is a sizable air gap? I'm leaning toward a middle ground scenario where we do get a sharp slide but shorts start to cover aggressively and bargain hunters come out of the woodworks. That would basically create a V-shaped correction. But what if the shorts refuse to cover, and the people who have money to buy physical (ie., China) decide to hold out for a better price (like bargaining at a market stall)?

Oct 27 04:44 PM

[JudeJin:]

people's bank of china bought physical gold in overseas market recently.

Oct 27 09:40 PM

[Laurence Hunt:]

Your point on style is generally valid. I for one find Mad Hedge's ideas so interesting that I don't notice it's all one paragraph. I just want to read what the gentleman has to say. However, point taken. Paragraphs are good.

On Oct 27 02:58 PM sofarprettygood wrote:

> MadHedge,
>
> I hope that someday you'll master the "enter" key so that you can
> separate your writing into paragraphs.
>
> In case you haven't noticed, newspapers present their articles in
> short paragraphs--because long paragraphs are difficult to read when
> working with narrow column widths. Your posts are way too difficult
> to wade through in their present form. I'm sure that many just can't
> be bothered, myself included.

Oct 27 09:49 PM

[Laurence Hunt:]

Adrian,

Top quality work as always. I was surprised that physical buying has fallen off so much. My gut feeling for the market tells me that we're going to see $1100 gold before $1000 gold. I know I should never be shocked at the market's behaviour, but gold miners are once again falling off sharply while raking in revenues hand over fist selling gold at record high levels this quarter. I'm not sure who's buying gold (I know the big government-funded banks are the commercial shorts in gold futures). But why anyone would sell gold stocks here? I just have to figure out how to own more, that's all!

I got taken with manya05's idea a couple of days ago that gold is "disappearing from the streets and accumulating in the vaults" (as GLD and other indicators attest). Is gold becoming a possession of the elites? Obviously the Chinese are buying it at street corner banks, so it's not an elite product yet. But I don't see how gold can ever be a currency again. It's worth too much!

In a world of fantasy and imagination, things which are real take on greater value. Who would carry gold in one's pocket at $1000 per ounce (or $2, $3, $4,000 etc.)? Obviously keeping gold at home is going to get more risky also, so many questions arise as to who can own and hold gold.

In the interim, I don't think that gold is going to falter greatly here on its way to becoming a favourite thing of the prudent and the elites. So futures or not, this is not the time to hold out for cheap gold...

Oct 27 10:02 PM

[Roger Knights:]

This article at least disproves one annoying slur: that gold is in the last phases of a bubble, with heavy "popular" participation.

Oct 27 10:09 PM

[Laurence Hunt:]

And that is very interesting news. $1000 gold is obviously not too expensive for these shrewd traders....

On Oct 27 09:40 PM JudeJin wrote:

> people's bank of china bought physical gold in overseas market recently.

Oct 27 10:09 PM

[JudeJin:]

mutual fund managers in china are known to prop up stocks that they bought using their own money under someone else' name.

i wouldn't be surprised that those managers at PBOC who make buy decisions of gold run their own commodities pool trading gold futures, confident that their 2 trillion dollar arsenal is more than enough to prop up anything they trade.

so the china "put" is quite real in this sense.

i heard there was a quite sizable pool put together by three well-connected rich businessman in shenzhen focused exclusively on gold and gold mines.

Oct 28 02:15 AM

[JudeJin:]

when we read news about indians buying a lot of gold, gold still has a lot of room to rise.
www.news.com.au/story/...

japanese,europeans, americans are 30 times richer than the indians!

Oct 28 02:34 AM

[Adrian Ash:]

Hi Screwloose -- there's a lot of wild comment doing the rounds about LBMA metal right now. I've seen the LBMA called a formal exchange (it's just an association), plus claims of "non-delivery" on the last day of the LBMA's Sept. futures contract (no such thing exists).

To the very best of my knowledge (we talk to the market 3 or 4 times a day, using a variety of dealers) there are no shortages or delivery hiccups. There weren't any problems even amid the surge of physical buying this time last year, back when retail coin dealers faced genuine shortages and premiums doubled and more.

Nor can you deal gold futures at the LME (a different organization altogether, but another mistaken claim online...), because the London Metals Exchange does NOT currently offer precious metal contracts. It's apparently been considering it though, perhaps spurred by the CME offering to clear loco-London forwards contracts. Far as I can see, London's wholesale dealers aren't much interested in that anyway.

All loco-London trading is done buyer-to-seller direct -- typically by phone -- in unique deals. That's why there is no single spot price, just an average of different quotes offered by individual firms at any one time. The two parties to each deal are on the hook, by themselves.

Yes, there are 5 market-making members, but that simply means they promise to quote two-way prices throughout London hours. The Good Delivery standards for LBMA-approved bars and storage make this OTC dealing more efficient than non-standard, unproven units would allow. LBMA membership makes for a network of high-repute, closely involved firms.

LBMA's guide to OTC gold is well worth reading:
www.lbma.org.uk/docs/O...

We also get an occasional jolly, like next week's annual LBMA conference. But it was scheduled for Lima, Peru, and then down-sized to Edinburgh, Scotland, because the bank dealers were told they couldn't justify the expense to their bosses amid the crunch.

Looking at bank profits now, you can see the respect gold dealers get, even with gold up four-fold in 10 years and even within their own organizations...

LAURENCE -- we're certainly seeing fresh business from chunkier clients, but as with most BullionVault users, they buy the dips, not the spikes. I'd like to think "weak to strong hands" applies to scrap-gold vs. investment demand over the last two years.

TOM -- if the Comex longs pull back by choice, I'm not sure the background would be urgent enough for physical demand to match what we saw after Lehmans collapsed. If they're forced out, on the other hand -- say by credit crunch part two, or even CFTC limits -- I'd expect real metal demand to jump on the dips once again.

On Oct 27 10:23 AM Screwloose wrote:

> Adrian
>
> Very valuable piece of analysis - thanks.
>
> What's you view on the state of LBMA physical stocks? There have
> been various strange occurrences of late that could be explained
> as hiccups in the supply chain - have you heard of anything similar?
>
>
> (I see Da Boyz are busy bashing today - anyone would think it's options
> expiry day.......)

Oct 28 11:28 AM

[Screwloose:]

Adrian

Always nice to get an insider's viewpoint. Thanks for taking the time to scotch the various rumours.

[Have a nice time in Edinburgh; it doesn't rain there in November - honest....]

Oct 29 01:59 PM