Sales Pitches Say Buy Gold; Fundamentals Say Don't

by: David White

Gold is known as a hedge against inflation; but the world is more worried about deflation at the moment.

The World Gold Council says Central Banks bought 374 metric tonnes of gold in 1H 2019. This is supposedly to get away from dependence on the USD.

The USD has still been rising. It has been in a strong uptrend since early in 2018. This argues against gold gaining value quickly.

Gold is a safe haven investment for many. However, will it be a profitable one if you invest in it now? I am presuming here that you are a US investor. The goodness of gold as an investment may depend on the local currency and many local political and economic factors. Dealing with the US situation is complex enough for me. I argue below that buying gold now is a mistake. Being neutral or even selling gold may be a better play.

The World Gold Council says Central Banks bought 374 metric tonnes of gold in 1H 2019. This is supposedly to get away from dependence on the USD. Many are expecting this kind of buying to continue. They are recommending gold as a good investment on this basis alone (Mark Mobius, for one). This may be a misleading thesis. It sounds rhetorically good; but it neglects some important facts that may make it a bad thesis.

The Biggest Buyer, China, Has Restricted Gold Imports

China has severely restricted gold imports since May 2019. This may have been done in a move to curb outflows of USDs. USDs tend to support the Yuan value. It could also have been done so that gold does not add to or create a trade deficit. A trade deficit would also tend to weaken the Yuan. China has been the biggest gold buyer in the world for some time. If China is expecting its exports to the US (and perhaps to elsewhere) to dwindle as 2019 goes on, it may be hoping to offset the lack of exports by cutting back on gold imports.

Chinese Customs data show that China imported only 575 tonnes of gold in 1H 2019. This was down from 883 tonnes in 1H 2018 (308 tonnes less in 1H 2019). Further the trend seems to be for even greater cuts. In May 2019, China imported 71 tonnes. This was down from 157 tonnes year over year. In June China imported 57 tonnes. This was down from 199 tonnes year over year. Chinese importation of gold for those two months alone was down -228 tonnes year over year. If China keeps up this pace, it may soon be importing very little gold per year. The above trend says Chinese importation cuts by themselves could easily outstrip the total world central banks buying of gold in 2H 2019. If you as an investor are counting on central bank buying to create a huge, extra demand for gold, you may be very disappointed. Then too there is no guarantee that the world central banks will keep on buying gold at their current rates. This too could significantly increase the supply, while decreasing the demand. The graphical depiction of the Chinese gold imports in 1H for 2018 and 2019 is below:

The Second Biggest Buyer, India, Is Trying To Restrict Gold Buying

India is the second biggest buyer of gold on the world markets. It recently raised import taxes on gold for this fiscal year (through March 31, 2020) by +2.5% to 12.5%. This is the first raise in 6 years. The last time India did this it was to prevent gold imports from negatively affecting the value of the Indian Rupee by adding to the Indian trade deficit. The same motivation is likely to be behind this raise in the import tax on gold. That means if gold importation does not decrease enough quickly enough, the Indian government is likely to resort to greater taxes or other methods to decrease gold importation. For now some pundits are expecting this one tax increase to cut physical gold importation in 2019 by -10% from the 760 metric tonnes imported in 2018. This will be in addition to the cuts being made in China; and India may arrange for further cuts to gold importation. Indian Gold imports totaled 37.7t in July 2019 (down 49% year over year). Gold buying is expected to remain muted in August and September 2019.

Other Factors In Gold Supply And Demand

World gold supply grew by 6% in Q2 2019 (or about 67.2 tonnes). This almost exactly matches or offsets the amount that the gold ETFs grew by in Q2 2019 (67.2 tonnes). In other words judging by the Chinese and the Indian situations, there should be a decrease in demand for gold in 2H 2019. That should lead to a decrease in the price of gold. A slowing EU economic situation may account for a bit of diminishing gold demand. If people start selling their $GLD investments in response to the above, we could see a rapid addition of supply to the market as perhaps 6% buying turns into 6% selling (an immediate 12% addition to supply). Supply and Demand Economics says that should bring about a fall in the price level.

Slowing Economic Times Often Spur Asset Sales - Including Gold

During times of slowing world economies, gold prices often go down. People sell gold because they have to have money to spend. In other words they sell gold much in the same way they sell other assets such as stocks during troubled times. If you believe there are troubled times ahead, you may wish to consider selling your gold before those times get really bad. We have seen slowing in various areas around the globe. Japan's finalized annualized GDP growth for Q2 2019 was +1.3% compared to +2.2% in Q1 2019. More generally the IMF lowered its July 2019 world economic outlook GDP growth estimate by -0.1% from its April 2019 estimates for both 2019 and 2020 to 3.2% and 3.5% respectively. This is slowing.

Alternatively people tend to buy gold during times of high inflation. We are not seeing high inflation currently. If China is the biggest gold buyer, its inflation may be of prime importance. The Chinese PPI year over year for August was -0.8% compared to -0.3% the previous month. This indicates disinflation if anything. That does not say, "Buy gold to investors." Further many pundits expect that the new tariffs by both China and the US will dampen economic growth going forward in 2019. Few expect a US - China trade agreement in 2019. Hence it seems likely that gold may fall this fall. Depending on the continued government practices of China and India and the state of the US-China Trade War, gold may continue to fall next year. The recent QE program announced by the ECB September 12, 2019 (€20B/month in bond buying) will likely work against this to push up the price of gold. The ECB also cut its deposit rate by -0.1% to -0.5%.

The recent chart of the USD is below:

The USD has been rising against major currencies and goods. This is not an infallible indicator. Still it does generally indicate a tendency toward weakness in commodities, including gold. The Fed Funds Futures show an 88.8% chance of a -25 bps rate cut on September 18, 2019. Such a rate cut would also likely buoy gold prices. The effect on gold prices is not likely to be big though.

The 1-year chart of the SPDR Gold Trust ETF (NYSEARCA:GLD) below shows there is likely a lot of room for a pullback.

If GLD falls, it could find a near-term bottom in the $120 - $126 range.


I am looking for weakness in gold prices at least in 2H 2019; but perhaps extending beyond that. The length of the weakness likely depends on the US - China trade situation (trade war). The above does not tell you that anything is certain. However, it does seem to belie the claims of the salespeople that gold can do nothing but go up. In fact gold and gold ETFs such as GLD seem likely to go down in the near term. If you believe in the Supply and Demand Economics Theory, it is hard not to believe that gold will go down this fall.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within 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.