Why gold demand is understated

Reuters recently analysed global trade data and concluded that a further 133 tonnes has been shipped directly to Shanghai this year. If we add that to the Hong Kong imports, we arrive at 989 tonnes. But as you’re about to see, even that still significantly understates the real numbers.

To dig a little deeper I spoke to Koos Jansen, a gold analyst who’s carried out a considerable amount of research in this area. This is what he had to say:

Simon Popple: “Koos, as we know, the main gold vein runs from the UK through Switzerland, through Hong Kong, eventually reaching Shanghai. What’s happening this year that’s so unusual?”

Koos Jansen: “Well Simon, although the Swiss, don’t publish country specific information on their gold trades, their numbers are very clear. Being one of the largest trading, refining and storage centres in the world, vast amounts of gold cross their borders. In 2012, they imported 2,267 tons of gold and exported 1,550 tons.

“On average, imports have transcended exports by 25% in recent years. But this has recently changed as the Swiss have imported 2,420 and exported 2,184 tons in just the first three quarters of this year. So not only is trade surging, but also the gap between import and export is tightening.”

SP: “So they’re exporting far more than normal.”

KJ: “Yes, and Switzerland’s biggest refinery has confirmed to Alex Stanczyk, who I interviewed in September, that all gold coming in from London is being re-melted into kilobars and sent to China.”

SP: “Does this all go through Hong Kong?”

KJ: “No, most is shipped to Hong Kong but some goes straight to Shanghai.”

SP: “But business with Hong Kong is booming?”

KJ: “Yes, so far this year Switzerland has net exported 697 tons of gold to Hong Kong. A surge of 445%(emphasis mine) compared to total net gold exports to Hong Kong in 2012.”

SP: “That’s incredible. What about your forecasts for the year. The World Gold Council is estimating Chinese consumer demand will be over 1,000 tons. But you think it’ll be more than double that.”

KJ: “I estimate Chinese demand for 2013 is 2,000 tons. This is because we can read from the “China Gold Market Reports”, which are written by the PBOC (People’s Bank of China), and anyone can download these from the SGE (Shanghai Gold Exchange) website, total Chinese demand is exactly the amount of gold withdrawn from the SGE vaults.

“Year to date there are 1,844 tons of gold withdrawn from the vaults, so it’s likely this will be more than 2,000 tons at the end of December.

“Supply includes domestic mining, though the bulk comes from the UK, the GLD and LBMA vaults that send it via Switzerland to China. Net exports from the UK to Switzerland are 1,109 tonnes year to date.”

Now, you’d think with this huge demand, the price should be going through the roof. But it’s important to remember two things: first, at the moment it’s in the best interests of the Chinese to acquire as much gold as they can as cheaply as possible; and second, the paper market is still in control and that’s how the price is fixed.

When there’s insufficient gold to settle these paper contracts and the trust in the systems starts to evaporate, then it gets interesting. We could be rapidly approaching that day.

  • Changing Man

    “When there’s insufficient gold to settle these paper contracts and the trust in the systems starts to evaporate, then it gets interesting.” Are these contracts settled in gold? Surely you buy them with currencies and redeem them in currencies?

    It seems to me that the Chinese are buying frantically ONLY because gold is cheap and that if the price rises, through physical scarcity, they will taper off their purchases accordingly. They can have no overwhelming need for more and more gold. They may want a major stake in the gold market, maybe even a wish for control, but surely not at any price? An equilibrium price is more likely in my view where supply meets (reduced) demand. What is that price? Well at the moment they are buying more and it is still falling which may be because of the paper trade or market manipulation or maybe because we haven’t reached that (lower) equilibrium price yet? As a holder of many gold shares, thanks to your compelling arguments, it worries me to think that the price may be $1,000 or less but it could happen. When miners become distressed sale bargains we may find the Chinese moving in to hoover up your “supply kings” at bargain basement prices.

    • Tyler Durden

      The only way the price concerns China is buying as much gold as possible for as little ‘fiat’ currency and the dollars they hold as possible.

      Beyond that, once you have it the gold ‘price’ means absolutely nothing. Besides, given that the gold price is dictated by the paper price and the physical price only gets down to that level because of the ability to satisfy supply – thus far – what exactly is the price of an ounce of real gold?

  • RedBaron

    It’s not just the Chinese who are buying. Often things can be overcomplicated causing confusion – stick to the basic principle of supply and demand – the demand is high/increasing and the supply is limited – so the price will rise – it’s ticking up as I write this.
    Changing Man: Hold on to your gold shares or take the opportunity to buy more.
    I have held PAF(amongst others) over the years and bought more recently. I am showing a healthy profit and will be getting a 6.5 % dividend in December- better than money in the bank.

  • Changing Man

    Dividends are a rare luxury with gold miners I find? I have little choice but hold Red Baron and have averaged down to try to mitigate my losses. These are SIPP holding so I can afford to wait. If all comes good I can retire early, if not I may be working forever!

  • AuBug

    As a Money Week reader I am nursing heavy losses on my original physical gold and gold shares purchases last year, so not very impressed with MW advice on gold in the past. However, recent additional share purchases may save the day – hopefully.
    If not, not only my MW sub will be unaffordable!

  • robin

    ” the paper market is still in control and that’s how the price is fixed”. – and that’s why the gold price isn’t really the gold price.

    If paper gold doesn’t have to be settled in gold, then the relationship between the security on the gold and the gold itself becomes very weak. An unlimited amount of paper contracts can therefore be written, so the very basis for buying gold, the fact that it cannot be printed, is violated.

    Paper gold is fundamentally a fiat currency. It amazes me what a con the concept of gold therefore is. Everyone seems to think that pinning something to gold will be a perfect inflation hedge, but what they are really pinning themselves to is nothing more than printed contracts.

    Last year there was some story about market makers refusing to settle in gold but they settled in dollars just fine. When this happened, they avoided having to acquire physical gold which would have driven the price up.

    If the world ever wakes up to this, paper gold will fall through the floor and physical gold will go through the roof.

  • Changing Man

    The pressure on gold prices this year appears to have been caused by naked shorting of gold contracts on the futures exchange (Comex), Gold wasnt sold or delivered, only paper, with trades settled in cash in daily volumes sometimes exceeding annual mine production. The motive, presumably, was to break the gold price for profit?

    Surely it was never intended that paper investments would dictate the price of gold, rather that the funds would track the price of the metal? Is it too late to address this? Someone?

    • Tyler Durden

      What’s certain is there will be a default, probably when China wishes it. As for when, that’s a waiting game for thos who hold gold presumably.

  • 5teadyeddie

    There seems to be a clear pattern this year of huge shorts being placed in short time frames to drive the price down, triggering stop loss selling by others, driving the price down still further. Presumably the initial short sellers then buy the contracts back during the subsequent hours and days to square their books and make a profit.

    This looks clear enough market manipulation to me, and I do think it’s significant that no-one in western governments seems to want to investigate it.

    But what I can’t understand is why anyone or any organisation would be long of the speculative paper market when the market is being manipulated against them very regularly.

    Forward selling by gold producers to fix their price is logical; forward buying by users to fix their price is logical – but these positions are for delivery and are not going to be regularly traded.

    So who are the traders or organisations betting (going long gold) in the paper market against the conspirators? They must have lost a great deal on money this year. If we understood this then maybe it’s possible to make sense of the whole picture.

    It’s also interesting that the precious metal markets have been exempted from the Volcker rule on banks trading with their own capital. Illogical unless the US government regards these (officially ‘non-monetary’ metals) as having special significance to it, the government.

  • Fl3tch3rb0y

    Below $1,300 gold, about 30 to 40 percent of mine production is probably not cash-flow positive