Real Gold Versus Paper Gold

There is currently a war going on between the paper gold markets of the Western speculators and the physical gold buyers elsewhere in the world. Right now speculators are playing games in the futures and options markets and generally driving the world price of gold much lower while the real investors and savers of the world are buying as much gold as they can get at those bargain basement levels.

By Brien Lundin
Wednesday June 19, 2013 16:11

Simply put, there is a war going on right now between the paper gold markets of the Western speculators and the physical gold buyers elsewhere in the world, but primarily in Asia.

While the speculators are playing their games in the futures and options markets, and generally driving the world price of gold much lower, the real investors and savers of the world are, thank you very much, buying as much gold as they can get at those bargain basement levels.

Massive selling on one side and massive buying on the other. So who’s right?

For one thing, there may not be a right or wrong in this contest. The huge surge in physical demand, for instance, is obviously fueled largely by the quick and deep reduction in the gold price.

Still, at any price, these people wouldn’t be buying gold if they weren’t concerned about the economic future. And gold has been in high demand for years as the global fiscal crises have emerged and expanded.

It is this physical demand that, in my view, represents the true supply/ demand dynamic for gold. The futures and options markets are essentially fractional reserve investing, with only the most tenuous relationship to actual trading in gold and silver.

Consider that, in the avalanche of selling for gold on April 12, about 400 tonnes of the metal was sold in the early hours of the trading session. That represented more than 100 tonnes in excess of all the gold in the Comex warehouses!

At its core, the futures markets represent nothing more than an opinion poll on gold, or a bet with a bookie, and those voting aren’t even buying or selling the actual metal.

Of course, the rise of the gold and silver ETFs have created a hybrid vehicle where futures-like trading can be done with a click of a mouse, with the purported effect of having actual metal bought or sold.

And it is in this area where the bears see particular weakness in the gold story. For years, the ETFs grew and grew, and showed every sign of representing “stickier” demand than futures. So when the ETFs started getting large and consistent redemptions, it was viewed as a sign that the gold bull was dying.

But using the ETFs as a proxy for global gold demand is a big mistake, and considerably misleading. As the accompanying chart shows, gold holdings in the two largest gold ETFs (GLD and IAU) have been falling since early December of last year. Since the beginning of this year, these two ETFs have lost a total of 367.81 tonnes of gold due to fund redemptions.

Over the same time frame, however, reports show that China alone consumed over 640 tonnes of gold — nearly double all the losses in the major gold ETFs.

And this is only the demand from China. You also have to factor in the massive buying from India (the world’s largest source of physical gold demand) and the rest of Asia, as well as the surging bullion demand in the U.S. and Europe.

Additionally, a number of central banks continue to buy gold. Russia, Turkey, Kazakhstan, Azerbaijan and even Greece added to their gold reserves for the seventh straight month in April, adding about another 30 tonnes to global demand in that month alone.

Add it all up and it’s easy to see that the end result of the stunning short attack in the U.S. paper gold market has been a dramatic net increase in global gold demand.

At the same time, the lower gold price is putting gold miners under greater economic pressure and, to some level, is reducing mine supplies.

So let the Western speculators play their games while they can. In every war, even the ultimate victors will lose a battle here and there.

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