Apr 302015

In January Steven Saville of The Speculative Investor newsletter wrote an article saying that “focusing on the changes in gold location is pointless if your goal is to find clues regarding gold’s prospects.” While I get what he was trying to debunk, I think he has thrown the baby out with the bathwater in doing so.

His target was specifically those who make the claim that “demand is rising even though the price is falling”, usually in respect of Chinese demand. I agree that this is a nonsense statement as for every buyer there is a seller, so to say that demand is up in China is the same as saying that supply is up in Switzerland.

Steven is correct that “the price trend is determined by the general urgency to sell relative to the general urgency to buy” and that price is the only way to know the relative urgency: “If the price is rising we know, with 100% certainty, that buyers are generally more motivated than sellers.”

So who is the baby that Steven threw out in his article? A clue is in this statement:

“while there could be a reason for wanting to know the amount of gold being transferred to China (I can’t think of a reason, but maybe there is one), the information will tell you nothing about the past or the likely future performance of the gold price”

It is the future price baby. When looking at the past, I could concede that price is probably all that matters, but when it comes to the future price, who bought (or sold) I think matters a lot. Steven himself says in his follow up post that “the most useful information is that which provides clues about the likely future intensity of buying relative to selling”.

Let me explain by an example. When I was a kid, football cards were popular. If you live on the moon, this is what I’m talking about.









I picked the first two names I recognised out of google’s image search. Apparently people collect these things. When I was a kid we used them to flick them and play snap type games and they’d get damaged quite a bit, then I grew out of them and gave them away.

Anyway, according to Steven, all you need to look at is the price of football cards going up. It is not important to know who was buying, say that it was a crazy old millionaire who was buying, stacking them in his house and never selling them – that would apparently have no impact on future prices.

I’d argue that it does matter if the buyers were a wide variety of normal collectors vs a market dominated by one crazy buyer. I’d like to know if he was keeping the cards in good order, or whether they were rotting away in a basement, and how old he was and whether his children had any interest in cards or would dump them on the market when he died. That seems all pretty relevant to the “future intensity of buying relative to selling.” Knowing who was buying in this case would give you an edge on guessing future football card prices.

To bring this back to gold, it does matter to me to know if the buying in size was coming from institutions/hedge funds (ETF flows give an indicator of this) or Chinese/Indians, for example. On the balance of probabilities on past behaviour, I would not want to make a long term bet on gold prices based on hedge fund buying as it is only a “trade” to those people and I could be sure they will sell up at some point.

However, given the known and demonstrated cultural hoarding behaviour of Chinese and Indians, I would have a bit more confidence that this gold would not be coming back into the market in the future. On the other hand, if one thinks that the Chinese economy is going to struggle, then maybe buying will drop off or even dishoarding will occur. Steve may not care to know estimates of how much gold is in China or India, but surely the bigger the hoard the bigger the risk that accumulation may stop (eg China gets enough central bank gold reserves to get into the SDR) or reverse?

Now while India and China are like black holes for gold consumption, I would point out that this is price positive only in the long term. It is a macro factor supporting gold but has less impact on prices in the short run, which is why if you run a correlation between ETF or Chinese flows to price you don’t get much. This is probably what Steven is rebelling against, this simplistic construction of a Chinese demand “meme” as respect to immediate prices.

The fact that people may be making the wrong assessment about the future (lack of) selling intensity of current gold holders, or that they are focusing far too much on short term prices, or that they may be using such “analysis” to pump their products/services (the bathwater), doesn’t mean not knowing who the market participants are (the baby) is not important. Reasoned and considered analysis of the current buyers and sellers and their motivations I think has some predictive usefulness.

Someone who would agree with me I bet would be HSBC and JP Morgan. As the two bullion banks with the greatest market share of the gold trade, they have access to information about where gold is flowing from and to well before anyone else. I find it hard to believe that seeing orders to buy gold (to replace sold coins/bars) from The Perth Mint and other mints and distributors, seeing orders from miners, jewellery manufactures, from scrap merchants and industry users – that all that “who” information is “pointless” for future price prediction.

Some people wonder why bullion banks are so successful and the fractional reserve bullion banking system hasn’t imminently failed. Maybe, just maybe, that knowing exactly who, when, where and how much is being bought and sold both in physical and paper markets is information that has value and gives one an edge.

  • Doolie

    The gold
    blogs have lots of ‘data’ on the size China’s and India’s gold imports, if these numbers are to
    be taken as true, then by current trend the size of these purchases exceeds annual mined output.

    The source of this gold is of interest to

    The soothsayers are saying that
    central banks are selling vociferously and ambushing the price of gold to
    support their fiat fairy tale. T

    To prove
    or disprove this not possible.

    A formal declaration
    of China’s gold holding may well cause curious minds to ask who sold it to them.

    Who is buying and who is selling doesn’t matter,
    unless it’s a central bank acting sly.

    • Victor Fantastico

      “A formal declaration of China’s gold holding”

      you make the traditional mistake of conflating “China” (as in the PBOC) with “The Chinese” – and it is only the latter who have a historical tradition of hoarding Gold; as a percentage of Foreign Reserves, “China” holds remarkably little Gold, compared to most western countries http://en.wikipedia.org/wiki/Gold_reserve

      We are faced with a Chicken & Egg situation – are The Chinese buying massive amounts of Gold because the price is falling, or is the price falling in spite of The Chinese buying massive amounts of Gold?

      In my opinion, it is the latter; the increased volumes purchased by The Chinese are surely correlated to increased affluence amongst retail purchasers and investors – more disposable income, more jewellery for Chinese New Year, weddings and Indian religious festivals. If this is the case, then as long as China’s middle class thrives, so the demand for Gold will increase, irrespective of price, and the fact that the price has fallen despite this increased affluence suggests to me that people in the West are far more motivated to sell than the Chinese are motivated to buy

      If this analysis is correct, and even a large amount of discretionary purchases by Chinese retail investors can’t arrest the fall in the price of Gold, then the propsects surely do not look at all encouraging if and or when the Chinese economy either slows down, or switches its attention elsewhere. The Chinese stock market has been booming this year, and if you were a retail investor, which asset class do you think would be attracting more of your attention?

      The Darkness still has work to do in the Gold market, and sub-$1,000 remains a real prospect

  • Motley Fool

    He lost me at “which means that neither a purchase nor a sale implies a market-wide change in demand or price.This is obvious,…”

    What is obvious to me is that he has little to no understanding how transactional supply and demand alters price on the whole.

    If his ‘obvious’ claim was true then supply and demand would not affect price at all, ever.

  • rowingboat

    Why are gold prices often (usually?) uncorrelated or inversely correlated to levels of consumer demand? It is because of hoarding and dis-hoarding and while this happens everywhere, at a national level which countries are the black holes and more importantly, which ones are the swingers setting price at the margin?

    Looking at the trade data over the past 20-30 yrs, the UK is clearly the dominant swinger as thousands of tonnes are imported into the London Bullion Market during the bull market and thousands exported during the bear. In particular, gold flows through the UK via Switzerland to the ROW but this supply is choked during the bull market as stocks in London rise. The reverse happens in the bear as the floodgates open.

    This explains why there’s such a high correlation in your chart Bron, the one comparing gold price with BOE holdings 2005-2014. When gold is eventually pulled back again into London, the price will need to rise enough to curtail Indian and next time Chinese demand as well, which should see fireworks in the price, imo.

    • http://goldchat.blogspot.com/ Bron Suchecki

      Good point on black holes vs marginal swingers. Thanks for reminding me of that chart, should update it and do a post on it.

      • rowingboat

        Everyone should be aware that the historical trade data of gold flows through Switzerland are now available, 1982 to present:

        Plotting all of this reveals so much, e.g. how West to East flows are reversible and correlate with price movements:

        1982-2000: net flow of 497mt from Switzerland to Hong Kong & China

        2001-2009: net flow of 334mt to Switzerland from Hong Kong & China

        2010-2014: net flow of 2,386mt from Switzerland to Hong Kong & China