Eric Sprott and David Baker have a new article out discussing central bank buying of gold and particularly China. I agree with his conclusion that this is an important demand side shift in the market but I think Sprott overplays the point with statements like:
"... there isn't a physical market on earth that can withstand that type of demand increase without higher prices over the long-run, and the gold market is no different. There are no sellers of physical gold that we know of who can satiate that scale of new demand ..."
"Who is going to give up their gold purchases to make room for this scale of new demand? Where is the gold going to come from? We ask because we don't actually know."
"We have written at length about the disconnect between the paper gold price and the physical gold market. If the demand changes stated above applied to any other market, the investing public would lose their minds."
"The paper market for gold can continue its charade, but demand in the physical market will soon overpower it through sheer momentum - there's only so much physical to go around, and it appears that there are some very large buyers that are eager to take it."
If Sprott and Baker "are students first and foremost of the physical market" then they would be aware that the one thing which makes gold different from all the other physical markets on earth are the large above ground stocks relative to new mine supply - 170,000 tonnes versus 2,800 tonnes.
This, I suggest, is a quite material fact and one which may be where "the gold is going to come from". Unlike "any other market", to which conventional supply/demand analysis can be applied, one cannot understand the gold market by just looking at annual supply/demand numbers when there is such a large overhang of stock.
What drives the gold price, I would therefore argue, is not so much demand, but to what extent existing holders of the 170,000t will withhold it from the market. It is actually supply – or more specifically, the withholding of supply - that matters most. If even a small fraction of these holders decide to sell, then that supply "will soon overpower" the physical market, China or no China. Don’t take this as a negative statement. The decade long gold bull market is a message that existing holders are requiring higher and higher gold prices to let go of their gold and that the new holders are more likely to withhold it.
The reason you don't often see this approach to analysing the gold market is because there are only sketchy numbers on the flow of gold from existing holders to new holders - ETF volumes, futures warehouses and scrap - and therefore it is difficult, if not impossible, to get any handle on total real supply. The result is most analysts just avoid it. It doesn't mean you should.
This unique feature of the gold market, which we can describe as "a stock overhang so large relative to new supply which would normally push the price of any other commodity to zero, but for some reason for gold it doesn't", is often referred to as monetary demand or by references to gold as a monetary metal.
This monetary motivation is not just about central banks holding gold (the only non-fiat currency thing they do hold as reserves) but also describes the motivations of most gold investors. Therefore understanding and tracking this motivation is crucial to managing your gold investment.
Gold is monetary in nature, with only a small commodity component. So when you see analysis taking a commodity-style focus on supply/demand, exercise some caution with the resulting conclusion.
Download today’s full Blog Watch (pdf 192kb) for more reviews, including:
GOLD STILL AMERICANS' TOP PICK
Gold leads four other types of investments in Americans' perceptions of which is "the best long-term investment" according to a Gallup poll.
Douglas Noland has an interesting piece on RORO, or risk-on/risk-off.
STATE OF THE PHYSICAL MARKET
There are a few articles supporting the weak physical market that the Perth Mint is experiencing at this time.