Eric Sprott and David Baker
has a new
article out discussing central bank buying of gold and particularly China. I agree with his conclusion that this is
an important demand side
shift in the market but then
Sprott plays it up way too
much with statements like:
"... there isn't
a physical market on earth that can
withstand that type of demand increase without higher prices over the long-run, and
the gold market is no different. There are no sellers
of physical gold that we know of who can satiate that
scale of new demand
"Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because
we don't actually know."
"We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market,
the investing public would
lose their minds."
"The paper market
for gold can continue its
charade, but demand in the physical
market will soon overpower it through sheer
momentum - there's only so much
physical to go around,
and it appears that there are some very large buyers that are eager to take it."
If Sprott and Baker "are students first and foremost of
the physical market"
then they surely are aware that the one thing which makes gold different from all the other physical markets on earth is its huge
above ground stocks
relative to new mine supply - 170,000 tonnes versus
This, I suggest, is a quite material fact and one which may be where
"the gold is going
to come from". Unlike
"any other market", to which conventional supply/demand analysis can be applied,
one cannot understand the
gold market by just looking at annual
supply/demand numbers when there is such
a large overhang of stock.
What drives the gold price
I would therefore argue, is not so much
demand, but to what extent existing holders of the 170,000t will withhold it from
the market. It is actually supply - the withholding of supply - that matters most. If even a small fraction of these holders decide to sell, then that
supply "will soon overpower" the physical market, China or no
China. This is not a negative
statement. The decade
long gold bull market is
a message that the existing
holders are requiring higher and higher gold prices to let go of their gold
and that the new holders
are more likely to withhold
The reason you don't see this
approach to analysing the
gold market is because there are only sketchy numbers on the flow of gold from
existing holders to new holders - say ETF volumes,
futures warehouses and scrap
- and therefore its difficult if not impossible to get
any handle on total real supply so analysts
just avoid it. It doesn't mean you should.
This unique feature of the gold market,
which we can describe as "a stock overhang so large relative to
new supply that in any other market
would push the price to zero, but for some reason for gold it doesn't", is often referred to as monetary demand or gold as a monetary metal. When you see
someone refer to gold as
a commodity, it tells you they don't
really understand the
gold market and you need to exercise some caution with their statements.
Gold is monetary in
nature, with only a small commodity component. Further proof of this is the fact that
central banks hold it as they generally
hold only money as reserves. A lot more can be said on this
but it is 8:30 on Sunday night.
The other thing I find interesting about the Sprott piece, and what I react to negatively, is the use of emotive phrases like "on earth", "lose their minds",
"charade" etc. Never a good thing when we are talking
about investing and its a
point Kid Dynamite has made, that Screwtape dissects, and which Erik Townsend makes quite forcefully in the Martenson/Harvey interview discussion.
Speaking of that
discussion and Sprott, for those
interested in Sprott's silver delivery problem, Jeff Christian has weighed
in with some interesting comments at the Martenson/Harvey interview. Warren James has updated Screwtape's post
on the issue with the relevant material
and it is a good summary and discussion of the "problem"
for those new to it (or who want a refresher).