China Supply Demand Dynamics May Drive Gold Lower

Includes: GLD
by: Robert Wagner


Contrary to conventional wisdom, China selling may be more important than China buying gold.

Continued economic weakness in China will likely trigger more gold selling.

Investors just seem to be moving on from financial collapse fear trades like gold and Bitcoin.

I've written many bearish articles about gold, and this one is no different. The news for gold just keeps getting worse. One of the main bearish themes has been how China will likely impact the price of gold going forward. In one article, I wrote about China's production, and in another article, I wrote about China's Central Bank buying of gold and a third wrote about China's internal dynamics impacting gold. New data has emerged which allows me to expand upon the third article mentioned above.

Recently the fall in copper prices has been attributed to the fact that Chinese loans are often backed with copper as collateral.

China consumes about 40% of global copper production. But not all of that goes straight into manufacturing or construction. Chinese companies have also been using copper as collateral for their hard-currency loans: "buy, store, hedge and pledge" in the words of one trader.

As the Chinese economy has stumbled, the fear of copper being dumped on the markets drove copper lower.

As banks worry about their customers' abilities to service debts, Chinese firms are finding it harder to get loans. This is making some sell their copper to raise cash.

This same concept however previously made the headlines, but it is just as applicable to gold as copper. Copper got the original headlines, but gold is now getting some attention in the articles as well.

A weaker yuan also undermined bullion's appeal for the so-called trade financing deals, in which Chinese investors use the precious metal as collateral to get credit. The discount "proved that as gold gets more expensive, it deterred price-sensitive Chinese consumers from returning to the market after Lunar New Year holidays,"

The Chinese "New Year and Love Trade" were covered in a previous article, and the above quote highlights/confirms the price elasticity and self limiting nature of those kinds of trades.

Supporters of gold will talk of the "physical demand" for gold being driven by the "love trade." The "love trade" is completely self limiting. As lovers drive the price of gold higher, it chokes off further demand. You can buy many dozens of roses and boxes of chocolate for the cost of a single ounce of gold. The higher the price of gold, the greater the opportunity cost as measured in roses and chocolates.

As I write this article, news that should be supportive of gold, the weak US economic numbers and continued but easing Russian aggression, has failed to be so. Gold is currently down nearly $7/oz, below the critical $1,300/oz and 200-day moving average. Other speculative quasi-currency fear plays like the Bitcoin are showing similar weakness. Investors just seem to be getting tired of the Armageddon/Apocalypse collapse of the global financial system fear trade. Investors just seem to be moving on to bigger and better things, and that isn't good for gold.

Lastly, the reason to sell gold is when there are better alternatives. As investors' risk tolerance increases, and they prefer returns over safety, the logical result is to sell gold and buy equities or other risky assets.

One last note, April 15th is approaching and many people are showing losses on their gold holdings. I would expect many people to sell gold to 1) take losses to offset 2014 gains and 2) sell gold to pay 2013 tax liabilities. I would not be surprised to see a large sell-off in gold just prior to April 15th. In fact, that happened back in 2013.

Apr 15, 2013 1:35pm

Gold plunged $144 an ounce today to its biggest two-day decline since 1983 as investors sold the precious metal amid declines in commodities of all types.

In fact, over recent history, gold often ends the week of April 15th down.

Disclaimer: This article is not an investment recommendation or solicitation. Any analysis presented in this article is illustrative in nature, is based on an incomplete set of information and has limitations to its accuracy, and is not meant to be relied upon for investment decisions. Please consult a qualified investment advisor. The information upon which this material is based was obtained from sources believed to be reliable, but has not been independently verified. Therefore, the author cannot guarantee its accuracy. Any opinions or estimates constitute the author's best judgment as of the date of publication, and are subject to change without notice. Past performance is no guarantee of future results. For my full disclaimer and disclosure, click here.

Disclosure: I have no positions in any stocks mentioned, but may initiate a long position in GLL over 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. I also own calls on GLL.