Jul 312015

I have written before on how gold is a pure epsilon asset and driven by narratives. This article by Michael Pettis takes a similar approach to China’s recent stock market problems but he makes a number of observations that apply to markets in general. I think these observations have application to gold in general as well as the current state of the gold market.

Michael notes that there are two types of players in markets – value investors and speculators. He says that markets dominated by one or the other type will generally behave differently.

A Market Dominated by Value Investors – Value investors base their decision to buy or sell on their interpretation of a piece of news. Because value investors generally vary widely in their investment strategies and interpretation, “small changes in the way news is interpreted or in market sentiment will have a limited impact on overall supply or demand” and thus prices.

A Market Dominated by Speculators – Speculators base their decision to buy or sell on their expectation of the collective interpretation of a piece of news. Because of the dynamics of the Keynesian beauty contest, in general speculator expectations “tends to converge very quickly” with the result being that “a market dominated by speculators is extremely sensitive to changes in the way news is interpreted or in market sentiment.”

Michael’s point is that where you have convergence, you will have higher volatility. Markets dominated by speculators will, as a result, generally be more volatile. A market dominated by value investors will generally have a wide range of views and be less volatile.

However, it is also possible for a convergence in investment strategies to occur (which he argues is happening in China today) making a value dominated market liable to explosions in volatility. It is also possible for a speculator dominated market to have uncertainty as such high levels that it undermines “the ability of speculators to agree collectively on how to interpret signals” resulting in a wide range of views and thus less volatility (but the potential for a big move once consensus returns).

Michael’s next point is worth a bulk quote:

“volatility can never be eliminated. Volatility in one variable can be suppressed, but only by increasing volatility in another variable or by suppressing it temporarily in exchange for a more disruptive adjustment at some point in the future. When it comes to monetary volatility, for example, whether it is exchange rate volatility or interest rate and money supply volatility, [or gold volatility?] central banks can famously choose to control the former in exchange for greater volatility in the latter, or to control the latter in exchange for greater volatility in the former. Regulators can never choose how much volatility they will permit, in other words. At best, they might choose the form of volatility they least prefer, and try to control it, but this is almost always a political choice and not an economic one. It is about deciding which economic group will bear the cost of volatility.”

The reason I found Michael’s article of interest is because I believe that gold is a market dominated by speculators. By that I don’t just mean evil Comex shorts – all gold holders are speculators. This is what I mean when I say that gold is a pure epsilon asset. That is not to say that we are all gamblers, betting on whether gold’s price will go up or down. In Michael’s conception “speculator” means one who is looking at consensus of what the market thinks, what sentiment is.

Don’t think you are a speculator? Then that means you must be a value investor. But to apply the concept of value investor to gold is to argue that gold has an objective or fundamental value. I don’t see how that is possible for an asset with such a large overhang of stock compared to annual flow, where the withholding of supply by existing holders matters most (as I argue here).

I don’t see how that is possible for an asset that is not productive, that is, does not earn an income. Even for that rare group who can lend physical gold, it is not the gold that is productive, it is the use to which it is put that helps to determine its interest rate (you can’t value a dollar by discounting the cash flows of its interest).

While value investors may disagree between themselves on what a company’s future ongoing earnings will be, they all agree that the method of arriving at “value” is to discount those earnings. But for gold no such discounting is possible. All these “fair value” models of gold, when you look at them are formulas based on correlations to other assets or macro economic variables like interest rates, inflation, etc (eg here and here). No value investor values Apple with a formula based purely on relationships to macro economic variables, simplistically they estimate current and future phone sales etc and the resulting profit.

Understanding whether gold is a value or speculative dominated market is crucial for the rest of my argument, so I’ll leave it there for now as I’m sure I’ll get some disagreement about gold being purely speculative/narrative driven and it might be best to let that discussion play out. If you think gold has a fundamental value, then please tell us what it is and the logic of your calculation. I’m ready to be convinced. On Monday I’ll continue with applying Michael’s ideas to gold and what it means for where we are now.

Jul 302015

So the gold price drops, so the gold forecasts drop. Some recent calls in order of bearishness:

Towards the end of 2010 I started recording forecasts in a spreadsheet, as I noticed many analysts revised their forecasts frequently in response to moves in the gold price. By 2012 I had given up as it was a lot of work to make one point – that in general analysts were just following or projecting the trend.

The chart below shows the forecasts I accumulated from late 2010 to early 2012 (the clustering around July are yearly average forecasts) and I’ve added in the recent ones above.


The first red arrow shows that in general most of the 2012 and 2013 forecasts were just extrapolating the 2011 trend, with varying levels of bullishness. The second red arrow shows that these recent forecasts seem to just be extrapolating the recent downward price trend.

Hard not to be cynical about it, especially since many were not out there loudly making these sub $900 calls before the mid-July gold price breakdown. Even Goldman Sachs, who were prepared to make a big call in mid-2013 for gold to reach $1,050, were about a year early, with their forecast being for 31 Dec 2014.

One of the most reliable forecast surveys has been the LBMA with the chart below showing their performance.


Generally the average yearly price has been within the highest and lowest forecast across the analyst surveyed (except for 2013). For 2015 however, the range is so wide as to be impossible for the price to not get within it, and thus not very helpful.

So far this year the average gold price is close to $1,200, compared to an average forecast of $1,211. If the gold price averages $1,050 for the rest of year the yearly average for 2015 will be $1,140, so it looks like the LBMA’s pool of bullion bank analysts will perform well this year, on a “wisdom of crowds” basis.

I’ll leave you with an upbeat prediction from my spreadsheet for gold to reach $5,000 by the end of 2015 by, surprise, Martin Armstrong (who has been putting the boot into the “gold promoters” recently), made in Dec 2010:


Martin has been negative on gold recently but I guess the $5,000 gold move hinges on his long mentioned 2015.75 Big Bang. If gold does indeed move up from the $1,000s to anywhere near $5,000 in the space of 3 months, that will be best gold call ever made.

Jul 292015

Yesterday Chris Powell of GATA criticised an article by Clif Droke on market manipulation. One point caught my eye, where Chris identified “an ‘ipse dixit’, an assertion made without authority” that Clif made, namely that “the market for gold is immensely huge and virtually impossible for any one entity to control its price swings … Even a coterie of interests devoted to pushing gold prices lower would meet with certain failure due to the enormous size and complexity of the market.”

It is one thing for Clif to claim that one entity could not control the gold market, but it strikes me as quite bold to claim a “devoted coterie” could not do it. To assess Clif’s claim we need factual examples of gold market liquidity so that we can “assert with authority” and solve this ipse dixit problem. Being the gold nerd that I am, over the past few years I have accumulated a number of statements about actual gold market liquidity (primarily because I’ve been annoyed with trite statements about how gold is “highly liquid” without any quantification) and thankfully now I have a use for them.

My simplistic understanding of “liquidity” is how much gold one can trade without affecting the market price. Below are some quotes that refer to actual trade sizes by people in the industry and their effect on price, both approximate and quantified.

  • Me, Feb 2012: “One could execute up to a tonne in one lot with a bullion bank at spot. … If someone was silly enough to ask a bullion bank to commit to a price for a 10 tonne lot, then from what I have been able to establish, the bank would adjust their spot price by around $10.”
  • Edel Tully, Nov 2012: “Brazil’s holdings expanded 17.2 tons last month … This is a chunky purchase … and was one of the key factors that gave prices a reasonable floor last month”
  • Mark Dow, June 2013: “Buying $300mm [7 tonnes] of gold can move the market up by less than a percent [$12 an ounce] in a normal market. But when sentiment for gold turns adverse, selling $300mm can drive it down, say, 2-3%.”
  • CNBC, Oct 2013: “Gold lost $25 in two minutes … a single sell order could be the culprit. It appears to have been an order to sell 5,000 gold futures contracts [15 tonnes] at market, Eric Hunsader of Nanex told CNBC.com”
  • ICE Benchmark Administration, Gold Auction Specifications: “Maximum Order Size 100,000 oz [3 tonnes] … This is a simple fat finger test designed to prevent the accidental input of large orders. In the event a user wishes to place an order greater than the maximum size they have the option to break the order down into smaller chunks”
  • Reuters, May 2015: “each interbank call would ‘shift orders of 50,000 ounces [1.5 tonnes] a time’, providing significant liquidity flows … Customers with smaller volumes are probably getting tighter spreads and better prices … but when somebody has size to do, especially with algos out there, it can hit pockets of illiquidity and cause spikes or flash crashes”
  • FT.com, May 2015: “if you want to transact in a decent size, which used to be 100,000 [3 tonnes] to 200,000 [6 tonnes] ounces. That has become harder to get away with without influencing the price unduly”
  • Me, Jul 2015: Gold drops $48 on 22 tonnes.

My takeaway from the above is that one can deal a couple of tonnes without affecting the gold price much – a bullion bank may widen the spread by tens of cents. However, once you get above 5 tonnes you will affect the price. From the quotes we get these figures:

  • $12 with 7t = $1.70 per tonne
  • $10 with 10t = $1.00 per tonne
  • $25 with 15t = $1.66 per tonne
  • $48 with 22t = $2.18 per tonne

What is 20 tonnes worth? At $1,100 per ounce it equals $700 million. Yes that is a lot, but there is a lot of money out there – for example, see this post where I calculated that if just “four groups decided to use only 2% of the $281.7 billion they manage to short gold. That would total 145 tonnes of gold”. Or consider what Ray Dalio said in this Sep 2012 interview “the capacity of moving money into gold in a large number is extremely limited … So the players in the world that … I have contact with, who are — who’ve got money — really don’t view gold as an effective alternative”.

That last quote is probably the best counter to Clif’s claim: the reason Ray Dalio and the coterie of players he has contact with don’t view gold as an effective alternative is because they would move the price, a lot.

Some may argue that such manipulations only affect the price in the short term and the price would recover as the manipulator buys back their position. True, if one wanted to cover themselves within the same day. But consider the July 20th price smash – yes the price has recovered, but it is still $30 below where it was before the selling. If the 22 tonnes was one person they could have bought back their position by now by buying only 3 tonnes a day, which as we have established above, would not move the price.

Chris argues that “is the gold market or any market really bigger than institutions that are fully empowered to create infinite money — central banks?” I would say the quotes above show that one hardly needs infinite money, as the gold market does not have the legendary but vague liquidity that many have claimed it has.

Jul 272015

On Friday I posted on the messaging China may have been sending with its central bank gold reserves announcement. Today I will update this analysis from 2012 to estimate how much gold the Chinese government unofficially holds and how much the population holds. I estimate that the total amount of gold in China is approximately 10,950 tonnes, with the population holding 6,490t, commercial banks holding 2,060t and the government, officially and unofficially, holding 2,400t.

How much gold is in China?

Koos Jansen estimates the total amount of gold within China at 13,781 tonnes. In large part the difference between Koos’ figure and mine is due to Koos assuming that the Chinese held about 2,500t of jewellery prior to 1994. In my 2012 post I quoted a source that notes that after the revolution all gold held by citizens, and gold mined, went to the government and was used to pay for imports. The analysis that follows does not rely on this total stock figure to work out official and other government gold holdings but it does affect the balance the population holds. If you agree with Koos then you can add the 2,500t to my 6,490t estimate of private stocks.

Where does China buy its gold?

It is my view that Chinese government acquires gold both domestically and from overseas, that all of it is held with China, and that any imports are reported in customs figures. Koos disagrees with this, arguing that as we see no figures in the customs category “monetary gold” from any country reporting gold exports to China, and since all SGE transactions are non-official, the government must be buying its reserves gold from overseas and importing it without having it declared.

I agree with Koos that “the PBOC buys gold in utmost secret or it would influence the market and geo-politics” and that they may make overseas purchases, but I find it hard to believe that China can dictate to the customs department of another country that their gold exports should not be reported at all (which would draw attention to the movement and negate secrecy). I also find it hard to believe that the PBOC would buy in its name from the overseas markets. It would be impossible to hide such activity from Western bullion banks and secure carriers and the information would leak out eventually, even if it could get the movements not reported in customs figures.

In my opinion, if the PBOC did not want to buy from domestic sources, it would request a Chinese commercial bank or a sovereign wealth fund to acquire gold in their name, import it as “for non-monetary purposes” and then get them to hold it until the PBOC wanted to officially acquire/report it. This method blends any PBOC purchases in with general gold importation flow, providing the secrecy it requires. As Huang Guobo, Chief Economist at SAFE, noted: “private demand for gold purchases is actually large but it is fragmented and intangible, and it is conducted through multiple channels and by multiple subjects that have less influence on the market, so this is more efficient in terms of the gold trade”, by which I take “more efficient” to mean “minimise price impact and maximise secrecy”.

Secondly, China does want its gold reserves to have some believability. If it was importing gold without any customs reporting, then Western analysts would have no basis on which to determine whether the reported reserves existed. By acquiring gold via reported imports (albeit in non-monetary form) and domestically, it allows the sort of analysis I will do below, which means that reported Chinese gold reserves can be assessed as to their reasonableness.

Koos also argues that the PBOC mostly buys gold from overseas. In Koos’ quote of the announcement, it says the purchases occurred “through various domestic and international channels … major channels of accumulation include: purifying domestic gold scraps and gold of various grades, direct purchase of production, transaction in domestic and foreign markets”.

I think the mention of “domestic” twice and the specific forms indicates that the purchasing was not solely from overseas sources. If it was mostly from overseas why mention all that detail? I note this Telegraph article where it says that a “division of the People’s Liberation Army mines gold and transfers the metal to the Chinese finance ministry, acting outside normal commercial channels. The government also buys gold directly from Chinese producers.”

Accordingly, I believe that the PBOC or its non-official arms could easily purchase from the domestic market without negatively affecting their policy of private gold accumulation. Indeed, during temporary slumps in the domestic market, non-official purchases could be a way of supporting the local mining industry and avoiding deep discounts within China to the London price.

How much is China buying?

In yesterday’s post I presented the chart below.


It makes a simple extrapolation between the dates of the official reported gold reserves figures (in red). The green area therefore represents an estimate of accumulation of gold by non-official Chinese organisations, which was then moved into official stocks at the date of reporting.

The chart below graphs this red/green accumulation from the chart above as a percentage of the monthly flow of gold into the Chinese market (that is, imports and newly mined domestic gold).


Notice that in the early years China was officially acquiring around 45% of all the flow of gold into the Chinese market. The percentage then declines from Jan 2003 (when China reported 600t of gold reserves) because the level of imports and mining increased greatly while we are assuming that the PBOC “gradually accumulated” during that period. While the accumulation was probably not in a straight consistent line, it nevertheless shows in general how little of China’s gold flow was being accumulated by the PBOC.

However, my green line is only an assumed official accumulation based on reported reserves. No doubt there has been other non-official accumulation but the question is how much of China’s gold flow is it reasonable of the Chinese government to have acquired without restricting its stated policy of encouraging private accumulation?

To answer that I turn to some estimates made by Matthew Turner, Senior Analyst at Macquarie Group (see this tweet) on how much gold Chinese commercial banks hold, based on their annual reports (see chart below).

If I add these figures (with some extrapolation back from 2007 to 2003) to our percentage flow chart, we get the following.


This I think is interesting, as it implies that as the Chinese commercial banks expanded their gold lending (mostly to domestic gold manufacturers to support the increasing jewellery and investor demand), naturally the government had to restrict its own acquisitions (in percentage terms, not in ounces) to ensure that a reasonable amount of gold was reaching the domestic market.

You will note that the purple line seems to run very much at the 45% rate that applies prior to 2003 (the red line). Does this constitute an official policy, namely that the Chinese government aims for the private citizens to accumulate 55% of gold flows? Pure speculation on my part and possibly reading too much into a pattern on a chart, but the best basis I think on which to make an estimate of unreported non-official gold accumulation.

If I then assume a policy of no more than 45% of gold flows into government (in the broadest sense) stocks, any time the purple line falls below 45% could be points at which other Chinese government organisations are accumulating gold. On this basis I produce the chart below.


The dark blue “Unreported Non-Official Accumulation”, which totals 745 tonnes by June 2015, is the calculated plug figure, if you will, to make government accumulation equal 45% of Chinese gold flow. Adding this to the official reserves gives a figure of 2,403t. If one wants to consider government controlled gold stocks in its broadest sense, then adding the commercial banks stocks gives you a figure of 4,460t.

It is possible that the PBOC leases some of its gold reserves to its commercial banks, in which case there is some double counting. However, if the 45% thesis is correct, then all that would do is increase the “Unreported Non-Official Accumulation” figure.

I would also note that this analysis does not include any gold purchased overseas and held overseas. This is a possibility but one that I give a low probability to because it means that China is taking on some exposure to Western banks to hold their gold for them and also because, again, it would be unlikely that such information would not leak out to Western governments, negating any strategic privacy that China may wish to have with respect to its gold activities.

One final chart, which takes the data in the chart above and expresses it as a percentage share of all gold within China.


This demonstrates the “sharing” of China’s gold stocks between the government and its people and that “the policy of ‘gold held by the people’ has been well achieved”.

Jul 242015

I don’t want to pick on Societe Generale analyst Robin Bhar, as this was representative of most of the commentary around China’s gold reserves announcement, but the statement that the 1,658 tonne figure “was not unexpected. If anything, it was slightly surprising that it wasn’t more, the market was looking at a figure north of 2,000 tonnes” makes the mistake of assuming that Central Bank announcements are about communicating facts.

As Ben Hunt says, Central Bankers “are all playing the Common Knowledge Game as hard as they can … if you don’t listen to what is being said in the context of game-playing, then you are placed at a disadvantage versus those who do. You will not understand the WHY that exists behind the public statements.”

So what is the WHY driving China’s gold reserves announcement? This note from Ben argues that “Chinese political stability under the unified coalition formed by Deng Xiaoping depends on robust and real domestic economic growth” and that “will depend on developed world export markets in the US and Europe”. That objective is not advanced by having a strengthening currency, making China’s exports more expensive, or as some goldbugs fantasise, “withdrawing from the system or blowing the system up” by reverting to a gold standard. But China cannot also dramatically weaken its currency lest it provoke Western governments into an overt currency war.

In terms of the why I think the timing, or WHEN, of the announcement was also significant.

It is also important to understand the audience the message is directed at, in other words the WHO. Ben notes that political linguistic game-playing often involves messages directed at multiple audiences, otherwise known as dog-whistling. In the case of the China gold reserves announcement, the choice of the figure revealed and how it was explained would have been a delicate, strategic balancing act considering the different perspectives of the players involved. Lets consider each of these audiences.

WHO – Foreign Governments and Central Bankers

Jim Rickards summarises the message China was sending to this audience in this simple tweet “China reveals enough gold to be respectable, but not enough to disrupt. Consistent with idea they want to join the SDR club, not destroy it”. Mark O’Byrne from GoldCore also makes the point that China “could be low balling their total gold holdings – official central bank reserves and non official holdings – in order to maintain confidence in their substantial US dollar holdings and to aid their bid to join the IMF.”

As news agency Xinhua noted, “China looks to advance its currency’s status as a key international reserve currency, which is now a prime candidate for the International Monetary Fund’s (IMF) special drawing rights (SDR)”. It is also interesting in terms of “join not destroy” that the article made the point that “countries have long abandoned the gold standard as the basis of monetary systems” before acknowledging that “gold reserve volume remains an important factor in market assessment of a country’s currency”.

I also find it interesting that the Xinhua included this quote from a researcher with the Shanghai Academy of Social Sciences: “China’s increasing gold reserves will strengthen yuan holders’ confidence, which will help stabilize the exchange rate and facilitate the internationalization of the yuan”. While directed at other central bankers, possibly it was also meant to encourage domestic investors to retain their yuan, rather than buying Australian or Canadian property, for example?

In terms of not disrupting, consider the chart below which shows the Chinese gold reserves additions as a monthly average rate of accumulation.


The recent 604 tonne addition is just a bit over 8 tonnes a month, which is similar to the rate of accumulation during 2001 and 2002. The message China is sending from this chart is that they are officially accumulating gold in a predictable and slow manner.

The steady as she goes message was reinforced by the People’s Bank of China saying, as reported by Reuters, that “on the premise of not creating disturbances in the market, we steadily accumulated gold reserves through a number of international and domestic channels” and would “remain flexible when deciding whether or not to adjust gold reserves in the future” with those channels being, according to Xinhua, “domestic scrap gold, production storage and trade in domestic and overseas markets.”

The consistency on China’s accumulation is better demonstrated by charting China’s reported reserves (in red) and filling in the gaps between the reporting points (in green) with assumed monthly additions, as I have done below.


The trajectory of the gold reserves growth is so bureaucratically predictable that I feel confident in extending the chart beyond today and saying that the next Chinese reserves announcement will fall on the my forecasted official reserves line depending on the date of the announcement.

Any figure greater than this predictable path would, as David Marsh of the monetary forum OMFIF said, “risk unsettling the world gold market” and “might be interpreted as an unfriendly move against the dollar at a ‘delicate time’.”

WHO – Domestic Stock Market Investors

Zero Hedge argued that “China had to wait until its stock market was crashing to present the ‘systemic stability’ bazooka: gold. Because in revealing a surge in its gold holdings, the PBOC is hoping to finally provide that final missing link that will boost investor sentiment, and get people buying stocks all over again.” Ross Norman from Sharps Pixley noted this argument but then said “but that makes no sense either, because they [gold reserves] aren’t!” sizeable.

Michael Kosares of USAGOLD provides a counter argument, noting that a “strong number would have propelled gold and the yuan higher – not what you might want having just thrown everything but the kitchen sink at the crashing Shanghai market. China in the end is an export economy, much like Japan. It’s stock market value relies on exports.”

I agree with Ross and Michael. Consider that the previous gold reserves announcement was in April 2009 when the amount increased from 600 tonnes to 1054 tonnes. The announcement prior to that was December 2002, which makes for a gap of 77 months. This increase being in June 2015 is a period of 75 months from the last, so one could consider this announcement should have been in August (assuming there is something special about the 77 month period). More relevant is the fact that the IMF meeting regarding the SDR will be in October, which means an August/September announcement would have sufficed.

So arguably the announcement in July about a gold reserves increase in June was early. I do not think it is coincidental that the announcement occurred shortly after China’s stock market fall. As the Chinese authorities would have been aware that market expectations were for a larger number, the reporting of a modest number sent a message to Chinese investors that while gold is important, it is not a major asset class and certainly not more important than the stock market. Reporting a large number would have sent the message that China was favouring gold and was the better asset to invest in.

Knowing that a lower than expectations figure would likely be negative for gold prices, China may well have considered it fortuitous that the gold price was weak at the same time they wanted to encourage people to invest in the stock market. As Jim Rickards tweeted “China is still buying gold and favors a lower price. So, timing the big ‘reveal’ for when gold prices are weak anyway makes perfect sense”, both for the State Administration of Foreign Exchange (SAFE) in terms of acquiring more gold and for discouraging domestic investors from shifting money from the stock market to gold.

WHO – Domestic Gold Consumers

For those without the wealth to invest in the stock market or property, gold represents a culturally familiar way to save. For this average consumer, the Chinese government would want to send a message that gold was still an acceptable investment, which the increasing of gold reserves achieves.

As mentioned above, the announcement also ensured that the gold price would not increase dramatically. The Chinese government would consider that essential, as a high gold price limits how much gold domestic consumers can accumulate, and could be seen by them as breaking the deal where the government can retain political power in exchange for individual economic improvement.

In this SAFE Q&A from 2010 they say that gold “has a very limited market capacity” and “if we buy gold on a large scale, the international price of gold will definitely be pushed up” which would “end up hurting the interests of our domestic consumers”.

This position was reiterated by Huang Guobo, Chief Economist at SAFE, in 2014 in this answer to a question about whether SAFE is “gold bargain-hunting”:

  1. “China now has a rational structure with both official gold reserves and active holding and purchase of gold among the people. Hence, the policy of ‘gold held by the people’ has been well achieved”
  2. “investment of foreign exchange reserves will have a significant influence on the gold market … if the price of gold is pushed up, then people will have to pay more for gold … which will be unfavorable in terms of our high consumption of gold”
  3. “when planning to invest foreign exchange reserves in the gold market, we must take into consideration its influence on the market and whether it will be beneficial for consumer groups in China that import a large quantity of gold”

Finally, consider what the PBOC itself said on Friday: “with an on-going policy of encouraging gold ownership by private individuals. It’s important to continue and consider the future of private investment demand as well as keeping international reserve asset allocation a flexible operation.” As Adrian Ash of Bullion Vault commented, “private gold demand … remains a key consideration for the People’s Bank when deciding its own gold-buying activity”, a case of “the state growing its own involvement, but letting private citizens take the lion’s share”.

With such a policy encouraging domestic gold accumulation, the gold reserves announcement helps to modestly reaffirm gold’s role and maintain a “favourable” gold price.

WHO – Foreign Gold Investors

As the Chinese government wants its population to accumulate gold (as well as itself), it would have been interested in coming under market consensus of how much gold it had. For the less game theory savvy Westerners who took the figure on face value, it would be read as bearish. For others, like

  • Joni Teves at UBS Group: “China hasn’t been very open about its strategy, so what matters now is whether the market believes they intend to continue buying … They do appear to leave the door open to further purchases, which should limit the downside for gold”
  • Georgette Boele at ABN Amro Bank: “Their motivation is reserve diversification, and they’ll probably keep buying”

the lower figures, while confirming that China will still be in the market, would not necessarily be bullish as these analyst and professional market players would have already incorporated that information into their calculations. The result is that there was little downside for China to report a lower figure given a higher figure may well have resulted in a large amount of retail Western investor buying.

WHERE – location and encumberance

The above discussion covers the Why and Who but I’d like to finish with some comments on the Where. Ronan Manly notes that there are two questions that no one has raised about the gold reserves announcement: “the storage locations of China’s official gold reserves and whether the gold is unencumbered”.

In respect of the encumbrance question, this is how gold is described in SAFE’s Template on International Reserves and Foreign Currency Liquidity (my emphasis):

Gold (including gold deposits and, if appropriate, gold swapped) – 623.97 [note this is in US$100 millions)
Volume in millions of fine troy ounces – 53.32

While no indication is given about the extent of Chinese deposits, lending or swapping, this wording does leave the door open to the possibility that China holds gold overseas, either as unallocated or allocated, or is involved in “actively managing” (as it is euphemistically referred to) its gold reserves.

As most analysts agree that China does hold more reserves than it announced last week, the question is where is this gold held? It does not mean that China was lying about its gold reserves, as costata001 tweets: “China could have bought that gold at any time in the past 30+ years. IMF rules only require reports when gold is classified as reserves i.e. monetary gold.” However, I do not think it is a case of the PBOC just changing the classification of gold it holds as monetary, given this definition by SAFE (my emphasis):

“4. Reserves assets refer to external assets that can be used at any time and are effectively controlled by the PBOC, consisting of monetary gold, special drawing rights (SDRs), the reserves position in the Fund, and foreign exchange.
4.1 Monetary gold refers to the gold held by the PBOC as reserve.”

So once gold becomes “effectively controlled” it becomes reserves. This means for the Chinese government to keep gold out of reserves it needs to keep it off the books of the PBOC. China is not unique in this regard. As Chris Powell notes, “Saudi Arabia pulled a similar trick in 2010. In June that year the World Gold Council reported that Saudi Arabia’s gold reserves had increased by 126 percent, from 143 to 323 tonnes, since 2008” but later revealed that it “had possessed that additional gold all along, holding it in what he called ‘other accounts’ but not reporting it”.

GoldCore have pointed out that in addition to the PBOC and SAFE, there are other Chinese government owned entities that may have also been buying gold, such as the China Investment Corporation or the “China National Gold Group Corporation or China Gold, China’s largest gold conglomerate with primary interests in mining and also refining”. Another location could also be the state owned banks active in the bullion market.

So when China decides that it wants to increase its gold reserves officially, it can acquire it from any of these entities. On Monday I will update this analysis from 2012 to estimate how much gold the Chinese government unofficially holds and how much the population holds, for what it is worth.

Jul 222015

I don’t know if this is the case in other countries, but here in Australia the TV news and other media report the USD gold price, not the AUD price. The result is that often gold will only appear in the local news when the USD price does something interesting or achieves new lows or highs, when for local investors the gold price may not have changed much or moved in an opposite direction.

The reporting of USD prices also means some Australian investors can get confused when they ring up to buy or sell and get quoted an AUD price and say a) “that’s not what it said on TV” or b) “that hasn’t gone up/down much since I last bought it”. While we do mention it to new investors, most forget about the impact of the Australian/US exchange rate on the AUD price of gold. This is best illustrated in the table below which shows an example of a perfect investor who bought the USD low and sold the high.

USD Exchange Rate AUD
24 Oct 2008  $   725.70     0.6528  $1,111.67
6 Sep 2011  $1,913.18     1.0527  $1,817.40
Increase 164% 61% 63%

For the American perfect investor they made a 164% profit but the Australian perfect investor (buying when the USD price bottomed and selling when the USD price topped) only made 63%. The reason is that the exchange rate increased 61% over that time period. You can see the interaction of the USD gold price and the AUD/USD exchange rate in the chart below, with our perfect investor buy and sell points marked 1 and 2 respectively.


If the exchange rate had stayed at 0.6528 the Australian investor would have sold at AUD 2,930.73 (a 164% profit). In this case the appreciating exchange rate cost the investor $1,113.33. Ouch. It is why we tell Australian investors about this rule of thumb: if the exchange rate goes up, the AUD price goes down (assuming a constant USD price) and vice versa.

So when you buy in Australian dollars (or any non-USD currency), you really have to forecast what the USD price is going to do and then what your exchange rate is going to do, and consider the interaction of the two. One way to get a handle on this is to turn the graph above into a scatter graph, which I have done below.


This type of graph doesn’t show time so well (I’ve marked the perfect buy point 1 and sell point 2 for reference), just the relationship between two factors. I have also put in coloured “contour” lines which indicate the points where the AUD gold price is the same across various combinations of USD price and exchange rate.

The really useful thing about this chart is that you can see that the AUD price has a tendency to move diagonally from left to right, following the contour lines. This means that there were periods where the AUD price was trending sideways or showing little change/volatility in its price – in other words, changes in the USD price were counteracted by changes in the exchange rate.

You can also use the chart to see what AUD price you get from various combinations of future USD gold and exchange rate figures. On the chart above it doing this is difficult because it covers such a wide range of different prices and rates. The chart below shows the combination of some more realistic medium term future USD prices and rates.


The white star is about where we are now, USD 1090 and a 0.74 exchange rate, which equals AUD 1473. The arrows represent various potential futures:

  • Green – Australian dollar weakens and gold bottoms and strengthens, in which case AUD gold would be above $1600
  • Blue- Australian dollar weakens and gold continues to fall, in which case AUD gold would be in the high $1400s
  • Yellow – Australian dollar strengthens and gold bottoms and strengthens, in which case AUD gold would be in the high $1400s
  • Red – Australian dollar strengthens and gold continues to fall, in which case AUD gold would be in the mid $1300s

The general consensus on the Australian dollar is that it will continue to weaken due to a poor economic outlook with commodity prices falling. As to the direction of the USD gold price, I think that is hard to call right now as we are in uncharted territory but the sentiment is negative.

What I would note is that there is a reasonable probability that the USD gold price and the exchange rate will continue to move together for the foreseeable future, as both do seem to be affected by the strength of the US dollar. In that case an investment in AUD gold may represent a reasonable bet as it is a case of a falling price (red arrow) scenario versus two neutral (blue and yellow arrow) and one positive (green arrow) scenarios. Of course I will probably be forced to eat my hat now that I’ve made that statement, but hopefully the charts above give Australian investors some help with making their precious metal investment decision.

Jul 212015

When the gold price has a big move the news agencies ring up traders for a comment. When I read these articles I’m looking for two things: why do traders think it happened and what do they think about gold going forward. Understanding these consensus narratives around gold is useful as they control large amounts of money and their views influence others.

Before I go on to discuss the comments, please note that narratives (see Ben Hunt) are not about truth, they are about what everyone thinks is the truth. For many finance professionals, the truth is less important (if at all) than being in the herd – most are not interested in the career risk of taking a position contra to the consensus view.

In terms of the why, here are some of the more sensible comments:

  • Ross Norman: They choose the optimal moment in the early morning and when Japan was closed for a holiday to get the biggest bang for the buck. It was clearly ‘short’ traders using leverage to trigger (technical) stops” he said. The price later regained some of its ground, allegedly as the profiteers cashed in jackpot gains on options that they also had. “It was a trade within a trade”. (link)
  • Marex Spectron: no coincidence that this happened in the quietest, thinnest period of the week … they deliberately want to move it in a big way (link)
  • “Traders”: Gold also fell in the Chinese derivatives market, which, traders said, added to the impression of an orchestrated attempt to push the price down, triggering others to sell their positions. (link)
  • Martin Armstrong: many rumors floating around from China off-loading because wrong storage figures were released, to a large spec investor who sold 6 tonnes and has taken a huge loss on a leveraged trade! (link)
  • “Traders and Analysts”: attributed the massive move to high-frequency trading algorithms as well as stop-loss selling. (link)
  • Societe Generale: It was just a bit of a bear raid and there was nobody on the other side to mop up the selling (link)
  • Chuck Butler: maybe the gold sale on the SGE was “margin influenced,” which would mean that large investors use gold as collateral on stock trades, and as the Chinese stock market has dropped the margin calls have come in (link)
  • “Market Participant”: The fact that it was done in Asian hours and in a loud, messy manner suggests it may be done by people not directly under European and US regulation (link)

The general view seems to be that it was a deliberate tactical move to push the price down, trigger stops, and try to get gold down to the technically important level of $1080, but with the real objective of making money on another derivative position. The last comment I find interesting as it implies that the activity was illegal, at least under Western regulations.

I have some sympathy with this “manipulative fund manager/HFT” theory. Gold has been technically weak for a long time and the professionals would have known that Chinese demand has been poor recently. Yes, you heard right, Chinese demand is crap. How do I know? Well, when the Perth Mint Treasurer tells me that he has instructed our refinery to make 400oz bars to ship to London because the lack of interest out of China for kilobars is so bad that the premium is below our cost, then I know that ain’t a good sign. I indicated Chinese demand wasn’t good here and while the permabulls weren’t telling you this (assuming they even knew what kilobar premiums were) the professionals would have known. So a perfect set up for them to try and break gold down. (FYI, Chinese demand has subsequently returned, so that is good, I’d rather not give London physical liquidity.)

On the conspiracy side, James Turk argued that “the US government did not like hearing China’s announcement on Friday about its 604-tonne increase in the official gold reserves of the Chinese central bank … was meant to embarrass China because it dared to announce an increase in its gold reserves. … It was meant to scare any remaining weak hands … also provided an opportunity for the bullion banks to cover short positions”. I tend to go with Jim Rickards that “China reveals enough gold to be respectable, but not enough to disrupt. Consistent with idea they want to join the #SDR club, not destroy it”. If anything, the announcement was so below market expectations and so low in terms of a percentage of China’s reserves that it sent a negative message, hardly something the US would be angry about.

One other small observation: the Telegraph said that “sellers dumped 7,600 contracts covering 24 tonnes on the Globex exchange in New York in a two-minute span after it opened late on Sunday night. A further 33 tonnes were sold at almost exactly the same time in Shanghai.” Looking at the SGE data, it seems that the 33 tonnes is a reference to the Au9999 contract. Firstly, as Koos notes, those figures are bilateral so actual volume was half of that. Secondly, that is just a total volume figure for the day so I wouldn’t call all that “selling” volume – last time I checked for every seller their has to be a buyer. I think the only valid way to characterise trading as “selling” would be off a detailed analysis of the bid and offer depth at a point in time and seeing how a trader took out all the bids, indicating a determined seller overwhelming buyers.

On to the narratives around gold after this price smash. Here are a selection:

  • Singapore-based trader: “We do see a lot of people in China selling gold to get fast cash to go back into the equity market” (link)
  • Phillip Securities: “It looks like the end of an era for gold, China has been grappling with oversupply after importing a record volume in 2013.” (link)
  • Societe Generale: “We have breached significant support levels, we know U.S. rate hikes are coming, there is no inflation and there is no catalyst to hold gold when other markets are doing better” (link)
  • Momentum Holdings Ltd: “With low global inflation and an improving U.S. economy, I doubt we’ll see big economic shocks, which is not good for gold” (link)
  • KBC Asset Management: “Gold is a hedge against everything that can go wrong. But at the moment it appears that not a lot is going wrong. We have an Iran deal, a Greece deal and we have good news from European and U.S. economies. There is no real reason for us to invest in gold and gold companies.” (link)
  • Deutsche Bank: “the “fair value” for gold is around $750. … “All the ducks are now aligned for a gold slide: real interest rates are rising, the dollar is getting stronger and the risk premium on equities is going down” (link)

So no change in the “improving US economy” and “Fed raise rates” story, indeed I feel that market participants see this price smash as confirmation of this narrative. That is not good for gold as it will give them confidence to test gold again. I’m not as confident as they are that everything is looking rosy and all the problems have been solved so I find myself agreeing with Adrian Ash that just like in 1999, this is a case of “peak hubris of policy-makers thinking they had abolished the boom-bust cycle” and that “gold continues to do what it does, rising when you need it and slipping when the financial world thinks it’s just a useless commodity”.

FYI Russian translation of this article Как подается крах цены на золото.

Jul 202015

I was just settling in to write an article on the increase in China’s gold reserves when at 9:30am the gold price got smashed. Initial news reports seemed to put the blame on the Chinese market, with statements such as “bullion fell to as low as $1,088.05 an ounce … shortly after the Shanghai Gold Exchange opened trading” and “According to ANZ, the sudden collapse in gold prices earlier in Asia was due to 5 tonnes of bullion being dumped on the Chinese market” but it started on Comex.

Nanex tweeted this picture which shows the first 4 seconds of the drop in the Comex August futures contract (GCQ2015). Note that it starts just after 9:29am Perth time.


Below is a 1 second time interval chart of the August futures contract from Reuters. The area in the red circle is the 4 seconds of the Nanex chart above, which puts the move into context.


The two green stars are 20 second trading halts. After the first halt the price opened up (the diagonal line) but then got smashed again after which another halt was imposed. This halt seems to have given people time to get their head around the drop and then step in for some bargain hunting and the price recovered above $1105.

Note that all this happened in the space of 1 minute and a lot of the detail that one sees on a Reuters tick-by-tick feed is lost by most traders using lower resolution charting/trading systems. The chart below comes from the CME website and you can see how it just shows the move as one bar.


Note that the volume traded in this one minute was 7,164 contracts, which at 100 ounces a contract is about 22 tonnes. ANZ reported that “half an hour after the market opened we saw 5 tonnes of gold sold through the Shanghai gold exchange, which is way above normal levels.” Reuters report that “more than 1 million lots were traded on a key contract on the Shanghai Gold Exchange”, which is equal to 10 tonnes.

The chart below shows 1 second intervals for the SGE and spot (over the counter) markets.


You can see that traders on the SGE reacted after the Comex price move and bullion banks did not update their spot quotes until 9:30 and a half minutes, 1.5 minutes after the initial Comex drop. This delay would be due to the fact that a bank is committed to deal on its bids and offers on an exchange whereas Reuters over the counter spot quotes are not actionable like an exchange (see here) so they are going to update the exchange quotes first.

Reuters’ article provided the following quote/”explanations”:

  • “It looks like someone was taking advantage of the low liquidity environment at the moment. It’s a bit of speculative selling going on,” said Thianpiriya [ANZ analyst]
  • There were stop-loss orders around the $1,131 an ounce level, said a Sydney-based trader, reflected in a spike in volumes on Comex futures.
  • “I just feel there’s a big push to get gold below $1,100 and then we bounced very quickly,” said a trader in Hong Kong.

While gold subsequently recovered to USD 1115, it is still down $15 from Friday, so objective achieved, we assume. With record short positions it doesn’t look like we have bottomed yet and are still waiting for the uptrend signal.

Jul 172015

In March 2015 the CME launched a gold kilobar futures contract. As with all futures contracts, vaulters apply to be a warehouse and as part of that they have to report registered and eligible stocks in their vaults. Currently there are three vaults reporting figures:

  • Brinks – 820,204 ounces
  • Malca-Amit – 36,909 ounces
  • Loomis International (ie Via Mat) – 17,779 ounces

The figures above are pretty representative of the average balances held by these three since the contract started trading. It is interesting that the Hong Kong warehouses have never reported any registered stock – it is all eligible. Compared to the CME’s US warehouses however, the 874,893 ounces of gold held within the Hong Kong warehouses is only 10% of the US stock of 8,751,688.

I hadn’t given the Hong Kong contract or its warehouses much thought until Ronan Manly, who writes for BullionStar, drew my attention to this submission by the CME to the CFTC “self-certifying the listing of a Gold Kilo Futures contract”.

As part of that submission the CME provides an analysis of deliverable supply so as to determine a conservative spot month position limit. To do that analysis “the Depositories that are intended to be approved by the Exchange … provided historical inventory levels of gold kilo bars stored in their respective vaults that meet the specifications of the Gold Kilo futures contract.” Those two depositories were Brinks and Malca-Amit.

The chart below shows the result of combining the data from the CME’s submission (monthly averages) with reported warehouse stocks for the HK contract supplied by Nick Laird at Sharelynx.com – note that the submission data only goes up to November 2014 and the contract starts trading in March, so we have a gap in our data.


You can see that someone(s) was accumulating kilobars all through 2013 and 2014, with the major surges being between Dec 2012 to Feb 2013 and Nov 2013 to Jan 2014. The interesting thing about that gap in our data is the massive drop of about 110 tonnes in the space of three and a half months. Where did it go?

The first theory may be that it went to the SGE to meet Chinese demand. However looking at exports from Hong Kong to China during that period shows no significant changes in volumes. There is also no indication that Chinese demand surged during that period, with SGE premiums (an indicator of demand) remaining subdued and SGE withdrawals at a high but relatively consistent rate.

The other possibility is that the owner(s) of that 110 tonnes realised that come March 2015 their previously unreported (at least until the CME submission) hoard of gold would suddenly become public, as CME futures warehouses, according to the CME rulebook, are (my emphasis) “required to report inventory to the Exchange .. Eligible metal shall mean all such metal that is acceptable for delivery against the applicable metal futures contract for which a warrant has not been issued.”

The purpose of that rule is to give the market visibility into potential stocks that may be traded on the contract, and also to avoid games where someone could take metal off warrant (no longer be registered) to give the impression there is little stock available to the market in the hope of giving the impression of a shortage.

The only way the owner(s) of that 110 tonnes could avoid be reported would be to move the metal into a non-CME warehouse, it being my assumption that the CME does not give exemptions to its warehouses on reporting the stocks of individual owners.

The chart below shows the combined Hong Kong and US warehouse data from Sharelynx.com. Note the data gap marked (1), which shows how significant the 110 tonne reduction was in terms of overall CME warehouse stocks. It is interesting to note that the area marked (2) begs the interpretation that metal was moved from the US to Hong Kong, although my cursory analysis of US-Hong Kong imports and US warehouse withdrawals does not confirm this.


I noted previously that the rapid “decline in registered gold stocks and delivery rates occurred soon after gold’s dramatic crash through $1550 and into the 1300s” and it is interesting to note that the rebuild of overall stock (in Hong Kong rather than the US) appears to have begun after gold bottomed for the second time at $1200 in December 2013.

One final note on the CME submission. As mentioned, the CME used Brink’s and Malca-Amit’s data to determine a “conservative” position limit: “As the basis for assessment of deliverable supply, the average monthly combined gold kilo bar inventory … is 89,408 kilo bars. Staff proposes a conservative spot month position limit of 6,000 contracts which is 6.71% of deliverable supply.”

Given the massive drop in Malca-Amit’s warehouse stock, I think it could be argued that a review of those position limits is warranted. The average Hong Kong warehouse balances since the start of the contract’s trading has been 27,730 kilobars (with a minimum of 17,296 bars and a maximum of 40,587 bars), which at 6.71% of deliverable supply would be 1,860 contracts, which we can round up to  2,000 contracts – compared to the current 6,000 contracts.

Jul 162015

The drawing of horizontal trend lines, support and resistance levels, Fibonacci levels and so on is a common technique for analysing price behaviour, setting stop losses and making trading decision. For examples of what I mean, see here, or here. However, in the case of GLD (and pretty much all metal ETFs) drawing them horizontally can be misleading.

The reason is that almost all precious metal ETFs pay for their management fees by selling gold from the fund to pay for the fees (while the number of shares outstanding remains the same). The result is that the amount of metal backing each share declines over time. This means that a share today is not equal to a share from the past – the prices are not equivalent. You are not comparing apples with apples, actually, you are comparing an apple with a fractionally smaller apple.

Most funds disclose the amount of gold behind each share on their website, usually listed as net asset value (NAV) in ounces. For the largest gold ETF in the world, GLD, its website was showing “NAV (in gold oz) Per Basket” as 9,585.06 ounces on the 14th. A basket (which is used by market makers) for GLD is 100,000 shares and when GLD started in November 2004 each share was equal to 0.1 ounces, so a basket in 2004 was equal to 10,000 ounces. Compared to 9,585.06, that is a loss of 414.94 ounces, or one London Good Delivery bar over the past 10 years – a fair bit when you think about it.

That loss is equal to 4.15%, which is basically GLD’s management fee of 0.4% per annum over 10 years. You can see the decline in the real underlying value of GLD’s shares by downloading its historical data. According to that spreadhseet, GLD’s closing price on the 14th of July was $110.74. Simplistically dividing by 0.1 would give you $1107.40 per ounce, yet we know that gold never got that low. If you divide the $110.74 by GLD’s actual gold backing of 0.09585063 you get $1155.34, which makes a lot more sense.

For a graphical example, the chart below takes GLD’s closing prices and draws some Fibonacci retracement levels from gold’s high, and from the 2008 low, but corrected for GLD’s declining gold backing.


You can see how they slope downwards over time, reflecting the loss of gold from the fund. It might not look like much on the chart, but consider the table below which shows the difference between the figures that would be normally be drawn horizontally and what those levels are adjusted to today to reflect the reduced gold backing.

Level August 2011 Figures Adjusted to Today
100% Fib $184.59 $181.71
61.8% Fib $114.08 $112.30
50% Fib $92.30 $90.85
38.2% Fib $70.51 $69.41
2008 Low $70.00 $68.17

A $2 to $3 difference on a $100 share is a fair margin of error, causing you to make a decision earlier than you should. Given the relatively small management fees, the effect is not material if you are doing analysis for period of less than a year. Something to keep in mind if you do draw levels on ETF charts, or the next time you see a technical analyst doing the same.