Gold's Invisible, Indirect Bull Market
Friday, 11/08/2024 11:32
Record gold highs come on 'missing' demand...
BIG WEEK, big yawn,
writes Adrian Ash at BullionVault.
Trump won, stocks jumped, the Fed cut.
"Trump is inflationary," or so everyone says, pointing at tariffs and deportations and unfunded tax cuts. But the Fed will keep cutting, or so everyone thinks.
Cue real yields in the bond market to fall. Yet
gold prices sank.
What gives?
"Gold, widely viewed as a hedge against inflation, has traditionally had an
inverse relationship with US real yields," says
a tweet
an X from Hong Kong-based financial research and wealth management firm Gavekal, posted on the eve of the election and
repeating a point we've made and come back to time and again in BullionVault's own research.
They also post a chart we're tired of talking about, too.
Why this link?
Gold pays no interest but cannot be inflated away. Cash and bonds do the opposite. Hence the inverse correlation between gold prices and inflation-protected debt yields.
"However," says Gavekal...
...inverting the right-hand axis on its chart, the better to show the strength of the connexion...
..."this relationship seemingly broke down in 2022, coinciding with Russia's invasion of Ukraine and the subsequent freezing of its forex reserves."
And the timing of this breakdown, says Gavekal, "implies that one of the major drivers of the ongoing rally in the gold price is the demand for diversification of reserves, where the security of the asset is prioritized over its prospective returns."
By reserves, Gavekal means central-bank reserves. And by security, it means the absence of political control by Washington or its allies.
This isn't news to anyone investing or trading the gold market. Central-bank demand has soared following the US-UK-EU sanctions against Moscow since the Kremlin began its all-out war on Ukraine.
But has it really? Not on the official data central-bank gold reserves data.
In fact, the numbers reported by
gold-holding central banks worldwide to the International Monetary Fund show growth slowing by over 40% since Russia's tanks rolled into Ukraine compared to the pace pre-invasion.
So instead, this latest boom has been invisible, showing up in the gap between visible gold demand and visible supply worldwide, and confirmed by intelligence, analysis and estimates from specialist consultancies such as
Metals Focus, whose data feed into the mining industry's
World Gold Council data.
Why hide? Central banks tend to be quiet if not secretive (or
just outright obtuse), the better to avoid scrutiny by meddling voters or analysts or indeed markets.
Many Western authorities, for instance, kept their
plans to sell gold invisible in the 1990s, only revealing what they'd done after the fact to avoid hurting their own sale-price during that decade's bear market. Today's big gold buyers also want to avoid front-running their own trades. And besides, why should they tell the IMF in Washington or any other post-WW2 organization what they're up to?
"The rise of the East and the decline of the West" is
how China's rulers in Beijing see the world today, says Australia's ambassador to the USA (and former Aussie Prime Minister) Kevin Rudd.
"We are now living in a period of great historical change the likes of which we have not seen in 100 years."
Russia's Vladimir Putin holds the same view, urging his counterparts at the recent BRICS summit of emerging-market nations to
pursue a 'new world order' pitting the West against the Rest.
So why play by the West's decades-old 'rules' of transparency, co-operation and fairness, all imposed at the point of a gun or the sharp end of Dollar-account sanctions?
Even where a gold-buying central bank has continued to update the world on its purchases, the appeal of gold stands out as a stateless currency...
...an asset which no one can create, destroy or control...
...making it very different to the US Dollar, Euro, Pound or Yen.
So the other big trend since 2022 both for invisible and reported central-bank gold buying has been for sovereign nations to buy in London – heart of the global gold market – and then ship it home.
Along with the New York Fed, the Bank of England is where central banks worldwide like to keep gold, ready to sell or lend should they need some cash.
Very little of those Bank of England gold custody holdings are actually British. But thanks to other central banks using its services, the BoE's gold vault tonnage set a series-record high in late 2021.
However, the quantity of gold entrusted to the Old Lady's care beneath Threadneedle Street then shrank by 1/8th in just 2 years, and while it has rallied, it still lags the growth in reported central-bank gold reserves worldwide, never mind the best estimates for total holdings including the invisible stuff.
Take India, for instance.
The Reserve Bank held 38.9% of its 760-tonne holdings at home in March 2022. That
proportion has since risen to 59.7% of today's 854-tonne holdings.
Why?
"Our gold was in a London vault. It is being brought back to an Indian vault. It makes no difference at all,"
claimed former finance minister P.Chidambaram when shipping some of India's gold to Delhi a few years ago.
But "we should care about it," said one
Twitter
X user this Diwali.
"We
don't want our gold to be blocked by the US in case of a conflict, just like they did to Russia."
So to recap, and like Gavekal says, emerging-market gold demand from "the Rest vs. the West" looks very likely a key driver of gold's big gains over the past few years.
But so too does another major event. Because that crack in how gold prices work, splitting from the traditional link with real US bond yields, "also coincides with the decline in the world's largest asset market," notes
a separate response on X.com.
No, not US Treasuries or even the S&P500, but Chinese property...
...estimated to have been
worth almost $90 trillion in 2022, ahead of the USA's total notional real estate value of $65 trillion.
Like China's real estate wealth, its stock market also began sinking in early 2022.
And with cash interest rates on the floor (aiming to revive share prices and real estate but to no avail), savers and investors in China were
left with little choice but to buy gold.
That's because, unlike you or me, they couldn't go out and buy go-go US tech stocks. Living under a Communist dictatorship means you can't get your money out.
So gold demand in the No.1 consumer nation leapt as property and equities sank, driving the Shanghai gold price sharply higher and boosting the incentive for new imports to fresh all-time highs in autumn 2023 as people piled into jewellery, coins and small bars, even gold-backed ETF trust fund products.
But here again, just as with central banking's invisible gold demand, China's private-sector rush into gold hasn't been completely visible. Quite the reverse, in fact.
Lots of metal went in – and lots got mined in China too (it's been the No.1 miner nation since 2007) – but reported demand just didn't match up.
This gap wasn't new in itself. But the size was. And so too was the solution to this puzzle for analysts and pundits. Because where gold-backed bank accounts used to plug the gap...
...with analysis in the mid-2010s counting up all the gold added to commercial bank balance sheets to explain where the 'missing' metal had gone...
...
China's commercial bank gold holdings have instead been falling.
"A total of 2,700 tonnes of gold has gone missing in China in the past two years," said economist Chen Long back in June (formerly at Gavekal, as it happens, but now running his own consultancy Plenum), "more than half of annual global gold production."
"There are several possibilities that could explain where it has gone," Chen went on, suggesting everything from central bank reserves to China's sovereign wealth fund or perhaps foreign banks importing gold and then holding onto it without reporting it on their quarterly filings.
But most likely, and especially amid the surge of private-investor gold demand, Chinese bank customers drove this hidden buying, adding metal which they own outright inside their bank's safe-deposit boxes or vaults, rather than leaving it on the bank's balance sheet.
Giving it to the bank in exchange for, say, zero storage fees, would be known as
'unallocated' gold. It lets you enjoy any price gains as a creditor only, rather than as an actual owner. It would therefore mean that the gold appeared on the bank's balance sheet, because it would belong to the bank. Whereas going
allocated (as you do by using BullionVault, only at vastly lower cost versus using a bank) means it doesn't show, because the metal isn't a bank asset (just like your property doesn't show on BullionVault's balance sheet either).
So again, as with central-banking's unreported purchases, this big move in Chinese gold investment doesn't show up in the visible demand data. And nor does the real kicker of the past few months' surge to high after high after high:
Indirect demand driven by speculation in futures and options contracts.
Today's final chart shows just how much invisible and indirect demand has been driving gold prices higher.
It uses data from the World Gold Council, who resolve this gap through what their
Excel spreadsheets call 'OTC and other'.
By that, they mean 'over the counter' transactions for wholesale gold and kilobars. Because as with our example of allocated gold investors in China, none of that will show on a bank or a broker's balance sheet if the client owns the metal outright.
The number also includes "changes to inventories on commodity exchanges, any unobserved changes in fabrication inventories, and any statistical residual."
Why rely on this fudge to balance the sums? Basic economics says that demand must exactly match supply. But even if we accept that thesis, not all of the buying will come from active demand, driven by a free decision to own more gold.
Instead, a big chunk will come from banks, brokers and dealers needing to hedge their exposure to gold-price bets made by their clients.
You see, whether or not any metal is involved, the futures and forwards tail really does wag today's spot-price dog. How?
First, if futures, forwards and options traders bid up the price of gold in 1 month or 3 months or 12 months' time, then the spot price will of course start rising too; and
Second, the more hot money that pours into those bullish bets on gold, then the more actual gold that somebody, somewhere along the chain, will have to buy to hedge their exposure in case those speculators turn out to be right.
This indirect demand has become a big part of gold's bull market in 2024. It started with the Chinese gold rush this spring, when that surge in real demand for coins and retail bars was outpaced by a surge in
speculative gold trading in Shanghai.
It then switched, via a brief spell of hedge funds apparently trading options and swaps in the London physical market, to US Comex contracts, where the speculative long position (net of that group's bearish bets) just set
a new all-time gold derivatives record by value.
What's been missing, however, was Western investment demand for coins, small bars, vaulted bullion, metal-backed ETFs or any other product directly involving physical gold. Whereas now, "Western investors are returning to the gold market," according to US investment bank Goldman Sachs, recommending gold
as a hedge against potential geopolitical shocks, trade tensions, Federal Reserve rate cuts, and
debt concerns.
"This
needs to continue to shift," says John Reade, market strategist at the mining industry's World Gold Council, because while "the last few years have really been dominated by emerging-market buying of gold – whether by central banks or in jewellery or bar and coin investment – those categories are beginning to slow down a bit.
"Western investors added to their exchange-traded gold fund holdings in the third quarter," says Reade, "so that's a positive start. But the physical coin and small investment bar market in the West still remains quiet. We need to see that improve for gold to trade sustainably higher I think."
Western demand stayed quiet because...
...unlike China's population, and unlike emerging-market central bankers fearing US sanctions...
...Western investors haven't been suffering a crisis.
Cost of living jumped, sure. But so did the stock market, and average wages, and house prices, even interest rates on cash in the bank too. And all while the jobless rate held near multi-decade records at or close to 'full employment'.
But this looks to be changing. US data for September's job vacancies and October's net hiring were awful. Western central banks have started cutting the returns to cash, just as Western stock markets struggle to regain or beat the late-summer's fresh all-time highs.
UK and French investors meantime face stark new tax rises, especially for larger savers and wealthier households, plus a fresh drag on jobs growth from higher employer taxation. Germany faces the collapse of its fragile coalition government, and Spain faces fresh turmoil between Madrid and would-be breakaway regions over its slow response to this autumn's terrible and devastating floods.
Cue a big jump in new gold investing among UK, French and Spanish investors. Italy too. Hell, even Germany is seeing new investors start buying bullion
after Europe's gold-market darling fell off a cliff when the Eurozone central bank finally moved to raise interest rates from below zero right around the time Russia invaded Ukraine and gold snapped its set-your-watch correlation with real interest rates.
So far, however, US investors themselves continue to sit out buying gold. Maybe that's because the Democrat candidate just lost (and was always going to lose). Maybe it's because the stock market continues to soar.
Either way, you can
read the full story in our latest Gold Investor Index data and comment.
As you'll see, Western gold investing demand...
...and its impact on precious metals prices...
...could be about to become very visible and very direct as Donald Trump returns to the White House.
But that link between real rates and gold prices? It's still broken, so far, since this week's election outcome.
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