China will save us

 Posted by at 10:02 pm  China, Narratives
Oct 162015
 

I have a lot of respect for Michael Kosares of bullion dealer USAGOLD but his recent commentary has a bit of the “China will save us” meme which has been around for many years and had its fullest expression in the Pan Asian Gold Exchange farce.

Michael notes the upcoming launch of a benchmark gold price by the Shanghai Gold Exchange and increasing involvement of Chinese banks in the setting of the London Price benchmark and says that “as a result, China’s influence in the gold market, already a key factor, should increase markedly and that “Chinese banks in London will be on the constant lookout for arbitrage opportunities that can be purchased and shipped to their home country”, concluding that “in this new gold market, China, perhaps inadvertently, will act as a proxy for gold coin and bullion owners all over the world” (my emphasis).

The tense of these comments – “increase markedly”, “will be”, “new” – implies that somehow China is not currently influencing the market to the fullest extent and involvement in benchmark pricing will help. This is just not the case. The Chinese government has approved all of its major banks to import gold and these banks have been very active in the kilobar market for many years now, something that the Perth Mint has experienced first hand.

As proof, consider this chart of the SGE premium. If there was any consistent restriction on China importing and impacting on the physical spot market this premium would not be near zero. Every week the Perth Mint offers 5 tonnes or so of physical gold to the market and we have rarely had a problem with banks, Chinese or otherwise, not being interested on bidding on it.

SGEpremium

Yes, there have been periods where premium develops, often due to demand surges which clear out onshore inventories and then the banks scramble for new supply from refineries worldwide, but the chart shows that in the long run the premium reverts back to more modest levels. As Adrian Ash of BullionVault says “it’s the Shanghai premium which, thanks to the magic of profit-seeking capitalism, draws in metal from abroad” – arbitrage is doing its thing.

So it isn’t a case that “China will likely serve as a foil to the current paper-based pricing regime” as Michael says, China already is serving as a foil.

Aug 032015
 

Michael Pettis argues that a market dominated by speculators tends to be more volatile as it is sensitive to changes (in consensus) in the way news is interpreted. If gold is entirely a speculative market, as I argued in Friday’s post, then we should see high volatility. While gold is more volatile than many other assets and currencies, it is not as excessive as we would expect based on Pettis’ theory. Why is this? I think it is because it is difficult for gold speculators to converge on a consensus view.

Divergence of Convergences

While I agree that the game theory-ish Keynesian beauty contest means speculators will converge on a view of a market, gold is composed of a number of groups with fundamentally divergent frameworks through which they view gold. A US Hedge Fund has a completely different view of gold compared to an Indian farmer, for example. Furthermore, many of these groups do not have a game theory approach – if you mentioned to an Indian farmer whether he is considering what all gold investors think about how all gold investors view gold, he would say “what the?” If participants are not aware of beauty contest dynamics then convergence doesn’t occur.

Note that within each group there is a convergence or agreement about how to view gold and when to buy it, there are just divergences between each group. Hence we have lower volatility as each group’s differing view counterbalance. The above implies that a savvy investor needs to implement a modified beauty contest: identify groups unaware of such game centric thinking and estimate their view of gold then identify game aware groups and then work out their view of the unaware groups plus their view of what game aware groups think other game aware groups think. Confused? No wonder no one can agree on gold.

Divergence Globally

In the latest World Gold Council (WGC) Gold Investor report they say break down the “drivers of gold into key factors: currencies, inflation/deflation, interest rates, consumer spending and income growth, systemic and tail risks, and supply-side factors.” Plenty of areas for divergent views. In addition, the WGC then point out that gold is a global market, so each of those factors differ between countries. I would argue that even if every gold market participant was playing a Keynesian beauty contest there is no way that with such a wide variety of factors to consider, and difficulty for the participants to communicate/signal their view, could any convergence occur.

Divergence Over Time

Adding to the complexity of the gold market is the fact that its structure is changing. As an example, it used to be that Western retail investors would run away when gold dropped significantly, but on the big drops in 2013 and 2015 we saw big surges in buying. Another example – consider the following two charts from the WGC Gold Investor report.

time

As the make up of participants in the gold market changes, then their influence on gold changes as well. WGC also makes good points on how conventional (ie Western professional investor) views about the influence of the US dollar and real interest rates on gold may be wrong.

Zero Correlation

I think the result of the above may explain why gold has no correlation to many asset classes. In the chart below from the WGC the correlations in red are not (statistically) significantly different from zero.

goldcorrel

Those assets with zero correlation to gold are basically equities and debt; the positive ones being commodities, and the big negative the dollar. It shows that there is no consensus about how gold should relate to equities and debt.

Current Market Situation

While I have been arguing that gold is basically a highly divergent market, at the moment I think there is a dangerous convergence on the idea that gold will continue to fall, certainly in the Western markets (as discussed here) but this would also affect sentiment in other markets. It seems to be primarily driven by narratives around US interest rate rises as signalled by the Fed. On that I’ll leave you with this from Pettis’ article, modified to suit the current gold market:

“In this market, you [sell] because you believe that everyone has agreed on the collective interpretation of government signaling. Anything that undermines the confidence you have in the collective interpretation must undermine your decision to [sell], and in fact because everyone is watching everyone else, at some point, this can become a collective decision to [buy].”

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 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.

chinaadd2

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.

chinaforecast

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 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 072015
 

The failure of gold to respond to Greece has attracted a lot of mainstream and goldbug comment. Goldbugs have focused on increases in demand as reported by coin dealers in articles such as this Bloomberg piece or directly by dealers such as USAGOLD (saying they had “experienced a strong surge of interest in June … [on] mounting concerns about Europe”) and Bullion Star (noting that “demand in the last week leading up to the Greek referendum has been about 150 % higher than normal”).

While Bullion Vault saw “internet traffic from Greece rise 50% during the first half of this year from the Jan-June period of 2014” they reported no new accounts from Greece, noting that “the preferred choice for Greeks buying gold has remained bullion coin. Specifically gold Sovereigns” which can only be bought from their central bank, the Bank of Greece – the volume of which had doubled according to the Royal Mint.

Predictably, goldbugs jumped to their favourite “disconnect” and “conspiracy” narratives, noting the failure of gold to go up in the face of this strong demand as proof of central bank market manipulation/rigging. Now don’t get me wrong, I certainly don’t deny central bank activity in the gold market (BTW, interesting that Barry didn’t respond to GATA’s questions). I mean, central bankers don’t pay $4,500 for the World Gold Council’s Executive Program in Gold Reserves Management to learn how to store, stocktake and shine up their stash.

However, sole focus on such a conspiracy narrative ignores the equally powerful professionals in the mainstream financial markets, the sizable money they control, and what narratives they believe about gold. I think we can’t ignore the question Koos Jansen asks: “are financial markets suffering from Euroscrisis fatigue?” and Blogger Bullion Baron sums up the attitude of these professionals well:

“A) After 4+ years of talk, Grexit has become the boy who cried wolf and the market now doesn’t pay the situation the attention it deserves.
B) The market (rightly or wrongly) thinks the Greece crisis no longer matters and will resolve itself without impacting global markets regardless of referendum or agreement outcomes.”

Here are just a few quotes to give you an idea of their views (size of their fund in brackets):

  • Huntington Asset Advisors ($1.7b): “Too many of the people who bought gold late in the rally have been scared off … people simply won’t go back to it.” (link)
  • Stifel Nicolaus & Co ($170b): “If we continue to see forward progress in the global economy, if the Fed continues to march towards interest-rate increases, you would expect gold to languish in those circumstances” (link)
  • RiverFront Investment Group ($5b): “They’re going to print money to ease the impact on the peripheral economies, which means further downside on the euro [currency] but upside for equity markets” (link)
  • Bessemer Trust: ($105b) “The risk of contagion to make it a European Lehman [Brothers] moment, is much, much smaller than a few years ago” (link)
  • Barclays: “The market has assessed that the risk of contagion from a Greek default is limited, more contained than in 2011 when Greece was last in the headlines” (link)

As an exercise, consider if just those four groups decided to use only 2% of the $281.7 billion they manage to short gold. That would total 145 tonnes of gold. Now estimate how many tonnes all those smallish coin dealers might have sold. Which do you think is bigger? With that sort of moneypower negative towards gold, central banks and bullion banks could easily sit on the sidelines.

As Gary Tanashian observes, “Gold is simply a marker, a barometer showing the state of confidence in the financial system and its managers (Central Banks) at any given time” and the quotes above show the confidence that professional money has in the system. It should therefore be no surprise then that Chinese bullion bank ICBC Standard Bank sees “scale up selling” on any rally in gold prices.

Are select central banks active in the gold market? Certainly, but market action is the result of many players reacting off each other and often engaging in narrative groupthink. Personally I think the mainstream professionals’ confidence is misplaced and they are complacent about Greece and how, as Ben Hunt puts it, we have “likely embarked on the death spiral phase of a game of Chicken” where “all sides begin to speak in terms of ‘having no choice’ but to take aggressive actions to defend their own interests.”