A surprise jump in investor and central bank gold demand
-- Published: Tuesday, 13 November 2018 | Print | Disqus
By Michael J. Kosares
LBMA consensus price prediction for 2019 –– $1532 per troy ounce
At the recent London Bullion Market Association annual conference, the consensus opinion on the gold price for 2019 among 682 industry delegates was $1532 per ounce. The LBMA offers its opinion annually and it usually falls on the conservative side of the ledger. So its consensus opinion of an average price more than 25% higher than the trading range at the time came as a surprise.
“This is the most bullish forecast since 2012,” said Ruth Crowell, chief executive of the organization which includes bullion banks, financial institutions, miners, and refiners. At the time of the meeting, stock markets were gyrating, the latest emerging country crisis was reaching a boil and geopolitically the global financial order was more precarious than it had been in a long time. Gold's safe haven role was back on the financial pages.
A few days later, the World Gold Council issued its quarterly assessment of physical gold market. Demand for gold coins and bullion, the category that tracks private investor interest, was up 28% over the third quarter of 2017. "Stock market volatility and currency weakness," read the report. "also boosted demand in many emerging markets. China – the world’s largest bar and coin market – saw demand rise 25% year-over-year." Central bank demand, another closely watched indicator of global interest in the metal, was up 22% over the previous year. "This," said the Council, "is the highest level of net purchases since 2015, both quarterly and year-to-date, and notable due to a greater number of buyers." In short, the World Council was reporting the strong business flows among the LBMA's professional community that fueled the bullish predictions.
Hungary makes a major gold purchase
One of the more intriguing central bank gold acquisitions reported this past month was that of Hungary. “In one of the most profound developments in the central bank gold market for a long time," writes Bullion Star's Ronan Manly, "the Hungarian National Bank, Hungary’s central bank, has just announced a 10 fold jump in its monetary gold holdings. The central bank, known as Magyar Nemzeti Bank (MNB) in Hungarian, made the announcement in Budapest, Hungary’s capital.”
The photo (above left) is from the public relations release issued by MNB accompanying announcement of the purchase. Each palette contains one metric tonne of gold and there are 28 of them – an impressively large procurement secured by Hungary’s central bank. Here is how the central bank described the acquisition. Its rationale for the purchase is worth noting in that it is the very same rationale that drives current private investor interest:
“Following the substantial increase in the Bank’s gold reserves in physical form, its repatriation has already taken place. The possession of precious metal within the country is in line with international trends, supports financial stability and strengthens market confidence in Hungary. In keeping with the historical role of gold, gold remains one of the safest instruments in the world, and, even under normal market conditions, provides a stability and confidence-building function.”
Gold coins, hoofs found in 2,000 year old Chinese tomb
“Chinese archaeologists. . . discovered 75 gold coins and hoof-shaped ingots in an aristocrat’s tomb that dates back to the Western Han Dynasty (206 BC – 24 AD), reports China's Xinhuanet. "The gold objects — 25 gold hoofs and 50 very large gold coins — are the largest single batch of gold items ever found in a Han Dynasty tomb. They were unearthed from the tomb of the first ‘Haihunhou’ (Marquis of Haihun) in east China’s Jiangxi Province. The coins weigh about 250 grams each, while the hoofs’ weights vary from 40 to 250 grams, said Yang Jun, who leads the excavation team.”
These gold artifacts were found along with a portrait of Confucius, perhaps the oldest known. Wisdom and gold make easy company. Confucius once said something that has current applicability: “In a country well governed, poverty is something to be ashamed of. In a country badly governed, wealth is something to be ashamed of.” Or at the very least, well-hedged . . . . . . . .
Has inflation returned to the United States?
We have alluded to the possibility of tariff-driven inflation in the past in this newsletter. Rising import prices – the result of de-globalization, e.g., the U.S.-China trade war – will filter ultimately to consumers. This will not be a monetary inflation but a political inflation and a different animal from anything we have encountered in the recent past. As such, we are entering uncharted territory – one in which politics could outweigh monetary policy in dealing with it.
We got some evidence of inflation's potential return to the United States in the October wholesale inflation report. Prices were up .6% from September to October – a 7.2% annualized gain and the biggest gain since 2012. Producer prices, as shown in the chart below, have pushed steadily higher since 2013. Some argued following the report that this increase should be dismissed as a one-time event. Ignored in those arguments was another statistic of more than passing interest: The core index, which excludes food and energy, was up .5% – or 6% annualized.
“If globalization is rolled back, as now looks likely, inflation will return," says Mark Asquith in a Spectator article. "The 1970s was the last time that Western inflation ran hot. Globalization killed that inflation. To imagine what reversing globalization may look like now, recall what happened in the 40 years since.”
As might be expected, in this whacky, upside down Alice-in-Wonderland financial environment, the gold price counter-intuitively turned down on the day the government released the report. The market took the report, we were told, as justification for further Fed tightening. More complex arguments about the Fed's policies including the inflationary deployment of excess reserves and the still negative real rate of return (despite the run of rate increases) were pushed aside.
In a financial environment in which good news for gold is interpreted as bad news, and bad news is still bad news – the day-to-day headlines might seem nearly irrelevant in determining the future price direction. Along the way, though, we suspect that the clock will stop running backward – rising inflation will come to actually mean rising inflation, and not something else, and rising inflation will come to mean higher gold prices.
Who owns the U.S. public debt? And what does it have to do with the price of gold?
Popular belief holds that foreign investors and central banks hold the lion’s share of the nearly $22 trillion federal debt. These charts from the St. Louis Federal Reserve tell the real story. Though it has not always been the case, private domestic investors now hold the largest share of the national debt at $13.1 trillion. Foreign investors are number two at $6.2 trillion. Federal Reserve banks are number three at $2.8 trillion. As you can see, federal debt held by private investors is on an ascending curve while both foreign and Federal Reserve banks’ purchases have leveled off. At present, private investors hold more than half the national debt (59.3%) as shown in the pie chart at the very top. Foreign investors hold 28.1% of the U.S. federal debt.
Both China and Japan, the two largest foreign holders of U.S. debt, are essentially defending their currencies and attempting to thwart capital flight. How that shakes out in the global foreign exchange markets remains to be seen but their intent seems clear. The financial media sometimes mistakenly promotes the notion that the reductions are related to the trade war, but once again, that simply is not the case, Japan has held their foreign exchange reserves steady since 2012 and China began reducing its reserves in 2014. In short, neither have been buyers of U.S. Treasuries in the aggregate for quite some time.
So what does all of this have to do with the price of gold?
In short, Japan and China, at least for now, are not complicit in driving their currencies lower against the dollar. Any future weakness or strength, it follows, will be market-driven – a posture that undermines the strong-dollar/weak-gold narrative. At some point the algo-driven speculators might be forced to give up on attacking the yuan and yen. In turn, they might be forced to give up attacking gold; and, in fact, begin covering their short positions on the COMEX. As it is, we have begun to see some unwinding in those positions of late for both gold and silver.
The latest from Michael Ballanger on the record short gold and silver positions on the COMEX
“Once again, and in honour of an ancient financial tradition, gold and silver fulfilled their respective roles as ‘precious’ metals, accordingly defined as ‘objects of great value; not to be wasted or treated carelessly.’ As we head into the final eight weeks of 2018, there are a great many managers of other people’s money who are paying attention—and it couldn't happen at a more opportune time. Tonight’s COT report shows that the Commercials were covering shorts into weakness while the Large Spec algobots continued to pile and add shorts/dump longs also into weakness. As long as the Large Speculators continue to carry such a paltry number of longs (13,194 futures only; 5,976 futures and options), the gold price should continue to trend higher through year-end. It is imperative to remember that major declines in gold have occurred when the aggregate long positions held by Large Speculators exceed 300,000; we are nowhere near that figure today and won’t until $1,400 is tested by year-end." – Michael Ballanger, Mining Junkie
Hedging financial warfare
“In this scenario," writes Daily Reckoning's James Rickards, "an attacker could penetrate the order entry system of a major stock exchange such as the New York Stock Exchange. Once inside the order entry system, the attacker would place large sell orders on highly liquid stocks such as Apple or Facebook. . . .The result could be a market decline of 20% or more in a single day, comparable to the stock market crash of October 1987 or the crash of 1929. You would not have to trade anything or be in the market during the attack; you would be wiped out based on the market decline even if you did nothing.”
This analysis from James Rickards, in our view, is his most important in a long time. Financial warfare – the ability of America’s enemies to penetrate and disrupt markets and infrastructure through malware and other forms of electronic weaponry – is something few investors contemplate. As Rickards, points out though, the threat is very real especially under the current tension-filled circumstances and prudent investors need to take it into account. “The key,” says Rickards, “is to have some portion of your total assets invested in non digital assets that cannot be hacked, wiped out or disrupted in financial warfare. Such assets include gold, silver, land, fine art and private equity that is usually represented by a paper contract and does not rely on electronic exchange trading for liquidity.” This is the financial market equivalent of living off the grid. We strongly recommend reading and contemplating the article at the link.
Taleb says world more fragile than 2007
“Nassim Nicholas Taleb, scientific advisor at Universa Investments, discusses the factors causing global fragility, hidden liabilities in global markets, and what he sees as safe trades in the current market. He speaks with Bloomberg’s Erik Schatzker onBloomberg Markets.”
Editor's note: When asked how it all plays out and if there is anything that he sees as safe in a global financial system on the verge of another crisis, Taleb says he owns “some gold, which I am confused about, and land. . .” He does not elaborate on why he is confused about gold. Taleb, as most of you already know, made his mark in the financial world by predicting the 2007-2008 crisis and writing the now famous book, The Black Swan – The Impact of the Highly Improbable.
Asia's wealthy investors prefer physical gold over ETFs
From the International Advisor: “Conservative high net worth gold investors prefer physical bullion over ETFs, says State Street Global Advisors. Private banks in Asia mainly use ETF vehicles when making active bets on gold based on a short-term outlook, Robin Tsui, gold ETF strategist at SSGA, said during an event in Hong Kong. For strategic allocations or longer-term investing, buying physical bullion and storing it in a safe remains the norm.” The same is true in the United States and Europe. Financial institutions and funds tend to favor the ETFs while private investors tend to prefer coins and bullion stored nearby.
The political versus the real deficit
There are two budget deficits – the political deficit that Washington and Wall Street throw around, and the real deficit that resides in real additions to the national debt. It is the latter, not the former, on which the U.S. government pays interest.“The US government said Monday that its deficit rose by 17 percent in its 2017 fiscal year that ended in September, as Washington spent $779 billion more than it collected in taxes," writes the New York Post's John Crudele. "But let’s look at the real number, which I gave you in a column last week. As I said previously, total US debt rose to $21.456 trillion by the end of the 2018 spending year. It had been $20.244 trillion at around the same time in 2017. That shows an increase in debt of $1.21 trillion.”
“Significant increases in inflation will ultimately increase the price of gold. Investment in gold now is insurance. It’s not for short-term gain, but for long-term protection. I view gold as the primary global currency. It is the only currency, along with silver, that does not require a counter-party signature. Gold, however, has always been far more valuable per ounce than silver. No one refuses gold as payment to discharge an obligation. Credit instruments and fiat currency depend on the credit worthiness of a counter-party. Gold, along with silver, is one of the only currencies that has an intrinsic value. It has always been that way. No one questions its value, and it has always been a valuable commodity, first coined in Asia Minor in 600 BC.” – Alan Greenspan, former chairman of the Federal Reserve
Image courtesy of the British Museum Collection/Lydia, croesid, ca 550 BC
“That said, in a crowded trade it only takes a few breaking rank to start a short covering rally … before it picks up a self-fuelling momentum before a rout follows, with gold rising very sharply to the upside. In short, the bears are looking vulnerable.” – Ross Norman, Sharps-Pixley
“Hedging the foreign exchange risk in this half-trillion-dollar per year business has exhausted the balance sheet of the global banking system. That explains a large part of the jump in the US 10-year note yield to 3.2% last Friday from 2.85% in early September. Hedging the foreign exchange risk in these massive flows created a derivatives mountain, and it has started to spew smoke and lava." We would add that foreign exchange hedging is only one area of concern on Derivatives Mountain – albeit a large one." – David Goldman, Asia Times
“Conservative high net worth gold investors prefer physical bullion over ETFs, says State Street Global Advisors. Private banks in Asia mainly use ETF vehicles when making active bets on gold based on a short-term outlook, Robin Tsui, gold ETF strategist at SSGA, said during an event in Hong Kong. For strategic allocations or longer-term investing, buying physical bullion and storing it in a safe remains the norm.” – International Advisor/Kate Lin
Editor's note: The same is true in the United States and Europe. Financial institutions and funds tend to favor the ETFs while private investors tend to prefer coins and bullion stored nearby.
“I think we’re getting to the point now where the breakout is going to be on the inflation upside. The only question is when.” – Alan Greenspan, February 2018
“But there’s fashion and there’s style; they’re not the same thing. Fashion is temporary and changes. Style is permanent and adapts. Investing in stocks, outside of a clear strategy based on a buy-and-hold approach, is often a fashion. Gold may be traditional now, but it’s never out of style. And it may soon become fashionable again. Indeed, the change, or the shift, has already begun.” – Alessandro Bruno, Lombardi Letter
Editor's note: The allusion to fashion reminds us of the old maxim that an ounce of gold from time immemorial would always buy a quality man’s suit. “The price of a fine suit of men’s clothes,” says the U.S. Geological Survey, “can be used to show anyone who is not familiar with the price history of gold just how very cheap gold is today. With an ounce of gold, a man could buy a fine suit of clothes in the time of Shakespeare, in that of Beethoven and Jefferson, and in the depression of the 1930s.” At present, a quality men’s off-the-rack suit at Brooks Brothers without the shoes and tie ranges in price from $1700 to $2500.
“[Bridgewater Associate's Ray] Dalio doesn’t seem to like very many assets. He does not like equities. He does not like bonds. He does not like the U.S. dollar. He does not like the euro. He suggests putting 5-10% of a portfolio in gold and weighting towards the higher range later in the cycle. He does not know where we are exactly, but we are pretty late in the cycle.” – GuruFocus/Bram de Haas
“Deflation is a threat posed by a critical breakdown of the financial system. Slow growth and recurrent recessions without systemic financial disturbances, even the big recessions of 1975 and 1982, have not posed such a risk. The real danger comes from encouraging or inadvertently tolerating rising inflation and its close cousin of extreme speculation and risk taking, in effect standing by while bubbles and excesses threaten financial markets. Ironically, the ‘easy money,’ striving for a ‘little inflation’ as a means of forestalling deflation, could, in the end, be what brings it about. That is the basic lesson for monetary policy. It demands emphasis on price stability and prudent oversight of the financial system. Both of those requirements inexorably lead to the responsibilities of a central bank.” – Paul Volcker, Keeping At It: The Quest for Sound Money and Good Government (2018)
Disclaimer – Opinions expressed on the USAGOLD.com website do not constitute an offer to buy or sell, or the solicitation of an offer to buy or sell any precious metals product, nor should they be viewed in any way as investment advice or advice to buy, sell or hold. USAGOLD, Inc. recommends the purchase of physical precious metals for asset-preservation purposes, not speculation. Utilization of these opinions for speculative purposes is neither suggested nor advised. Commentary is strictly for educational purposes and, as such, USAGOLD does not warrant or guarantee the the accuracy, timeliness or completeness of the information found here. (Please see our Risk Disclosure here.)
Michael J. Kosares is the founder of USAGOLD and the author of The ABCs of Gold Investing - How to Protect and Build Your Wealth With Gold. He is also editor and commentator for USAGOLD's Live Daily Newsletter and editor of the News & Views monthly newsletter.
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