Reversing gold flows could lead to Perfect Storm

(June 3, 2016 - By Lawrie Williams)

For the past four years, physical gold has been flowing in large quantities from West to East, depleting Western warehouse stocks – some would suggest to crisis levels.  A significant amount had come from the running down of holdings by the gold ETFs, without which the predominantly Asian intake, dominated by Indian and Chinese imports, would not have been able to be satisfied without a big increase in the gold price.  If that had occurred, it would probably have interrupted the flow pattern with the ETF liquidations falling off and the price-sensitive part of Asian demand also being reduced. 

A recent Commodity Spotlight report on precious metals from Germany’s Commerzbank’s analysts sets this pattern out well, but we’re not sure its conclusions are entirely correct. It also perhaps was prepared too early to pick up on the latest Swiss gold import and export data which would seem to confirm the pattern indirectly. This article points out that in April Switzerland was comfortably a net importer of physical gold from Hong Kong and from the United Arab Emirates when normally gold flows are strongly in the other direction. This suggests that demand normally serviced by the gold sellers in these two important areas had slipped sufficiently for the traders to be reselling excess stocks – presumably at a nice profit given the rise in the gold price that month – back to the Swiss refiners from whence the gold came in the first place, Switzerland being a key hub in international gold flows.

The article above also pointed out that Switzerland’s biggest export market for gold that month was the U.K. – again normally the major source of Swiss gold imports – another very significant flow reversal.  We speculated that this was largely due to the huge demand which had been coming from the major gold ETFs, which vault most of their gold in London, suggesting that supplies of unallocated gold in London might have been insufficient to meet this demand.

Since then demand for gold by the big ETFs has faltered a little, but still remains positive. This has been despite lower gold prices as a result of U.S. Fedspeak which has raised the spectre of earlier interest rate increases than most had been anticipating – perhaps as early as June.  Fed rhetoric, and policy, may well be a means to an end in trying to reduce speculation on the gold price given that a rising gold price is perceived by many as a global indicator of a weak U.S. economy – and a rapidly rising one as a global condemnation of the dollar.  The Fed may not want a sharply rising dollar because of its impact on an important sector of the domestic economy, but it doesn’t want a rapidly falling one either because of the global perceptions this would engender regarding overall economic strength.

Gold coin demand has also been extremely strong this year so far in the U.S. and Europe - very substantially above that of a year ago which means investors are buying physical metal as well as ETFs.

India has seen perhaps the biggest apparent demand fall so far this year with gold imports down hugely – but statistical data takes no account of gold smuggling to avoid the fairly substantial import tariffs.  A recent report suggested that smuggled gold may be running as high as official imports.

Chinese demand is down significantly so far this year too, but both the Chinese and Indian markets can be price-sensitive and the weaker gold prices we have seen of late could start re-stimulating demand there too.  There are reports of good monsoon rains in India which would likely boost demand in the stail end of the year, with the rural community accounting for much of India’s gold demand.  

Commerzbank comments too that the Chinese investor may be finding gold attractive again given that property is seen as overpriced and the big fluctuations in the stock markets make investment in these look particularly risky.  Don’t forget the Chinese economy is still growing, albeit at a slower rate, and the middle classes, which tend to be the gold buyers, are still expanding with numbers probably now exceeding the total U.S. population.

Black Swans:  A week or so ago the likelihood of the U.K. populace voting to leave the European Union in just three weeks’ time seemed remote and many observers had been writing it off completely.  However recent immigration statistics have brought the prospect of uncontrolled immigration via the EU’s open borders to the forefront and that is a worry for a big sector of the working population.  Whether the Leave campaigners (Brexit) will be able to control immigration any better in the event, is largely overlooked.  Some latest opinion polls put Brexit in the lead and this observer now sees Brexit as a very strong possibility indeed.  Most of the big names on the political and economic front will be out in force for the Remain campaign, but the working public’s distrust of political and economic statistics could mean the dire warnings of economic downturn, or even chaos, may well be ignored.

Should the Brexit option be chosen it will not only raise huge economic doubts about the prospects for the U.K., but for the whole of the EU too, given an underswell of anti-EU feeling across the Continent.  The wealthy will see this as having the potential for depressing the value of the pound and the euro against the dollar – perhaps significantly – and gold may well be the considered safe haven investment option.

And then there is the U.S. Presidential election in November – only just over 5 months away now.  While the prospect of a President Trump would have seemed hugely unlikely only a few months ago, it could now become a reality.  Whether a President Trump would be good for the U.S. or not is neither here nor there, but the possibility would hugely raise economic and geopolitical uncertainty given his populist, and protectionist, rhetoric – and economic uncertainty can drive the big money into gold.  We seem to be seeing this already in terms of the rising investment in gold ETFs.

And there is always the likelihood of other gold positive Black Swan events coming about between now and the end of the year!

Now if all this happens and Asian demand starts to pick up again, this could truly be the ‘Perfect Storm’ for gold and all predictions from the mainstream analysts, who are mostly looking for a year-end price of between $1200 and $1400, could be hugely overwhelmed.