Let’s look into the crystal ball to see what 2016 – The Year of the Monkey - has in store for us when it comes to the gold market.
What will the price of gold be at the end of 2016? Will it dip under USD 1,000/oz?
To answer that question, we first have to analyse what causes the price of gold to move. Supply and demand of physical gold, right?
Physical supply and demand have little to no effect on the price of gold. The price of gold is set on the paper markets and pre-dominantly on the OTC market in London. The volume traded during one day on the London Gold Market is at least 88 % of an entire year’s gold mining production. One year’s trading volume in London is at least 170,195 tons whereas annual global gold mining output stands at 3,100 tons.
Whether demand during the Indian wedding season or during the Chinese New Year is up or down 5 tons matters little when, on average, there’s at least 2,756 tons traded each day on the London market, the market which serves as the price discovery market.
If anything, an increased demand for physical gold correlates to prices decreasing. Bullion banks can create paper gold out of thin air and are particularly prone to do so when the physical demand is high. There’s furthermore a substitution effect with more concerned savers and investors shifting from paper gold to physical gold.
As I explained in my presentation at BullionStar’s 3-year anniversary recently, I may be the only bullion dealer around who is claiming that a decreasing gold price is good and healthy. As the fiat mess burns itself out, a decreasing gold price is to be expected as paper gold is part of the fiat mess. Paper gold, like fiat money, is created out of thin air and its price may very well go all the way to zero, as all paper assets eventually will.
Don’t expect however to find any physical gold for the price of paper gold when this happens. On the physical market, there’s a finite quantity of gold available in the world. The quantity of gold stocked in London, the historical centerpoint for gold trade and gold storage, is shrinking quickly as pointed out by BullionStar’s excellent research analyst, Mr. Ronan Manly in this blog post.
Another sign of western vaults being emptied by the day is the decrease of gold holdings in GLD. Contrary to popular belief, the reason for the GLD stock decrease is that the bullion banks need to deliver the gold previously checked in with GLD to customers taking physical delivery or to keep it in reserve themselves.
I thus see two scenarios for the developments ahead.
1. A continuation of what we have seen in the last three years. Physical demand continues to increase over time. The price, as denominated in USD, goes down. At a point during this slide in price, physical gold supply will dry up as we simply run out of stockpiled available gold. The gold market come to a standstill after which the price for physical gold decouples from the price of paper gold. Paper gold goes towards zero and physical gold revalues significantly in terms of purchasing power. This is where we are heading assuming a continuation of the trend we have witnessed over the last three years.
2. The paper market is quickly overwhelmed with demand for paper gold triggered by paper investors moving in due to other markets crashing. The bullion banks are surprised to the extent that they don’t manage to keep up their issuance of paper gold. The price of gold goes up.
The price of gold would of course also go up in cases where the markets were to be rejuvenated with price discovery originating from the physical market place. This will ultimately happen in the first scenario above but only after the paper markets have crashed.
The most likely outcome, although it may be delayed beyond 2016, is that there will be a disconnect between the pricing of paper gold and physical gold. We have lived in an environment of increasingly murky price discovery for gold since the 80’s following the introduction of various forms of paper gold.
Remember that it’s better to buy gold one year too early than one day too late.
In the not too distant future, paper (money) may not buy you any gold at all.
Gold Industry & Market Opaqueness
Government and central bank gold policy is shrouded in secrecy. Clumsy central bank press releases are often raising more questions than providing answers. The balancing act lies in keeping enough gold to keep confidence up in the fiat system but not too much as it would signal an anticipated weakness. The resulting ambiguity and opaqueness doesn’t do the gold industry any good when it comes to supporting the environment for its participants.
One of the most important geopolitical trends of today, almost totally ignored by mainstream media, is the immense flow of gold from the west to the east.
Physical gold demand in Asia generally and China in particular is insatiable and everything points towards a continuation of this trend in 2016 and beyond.
China is working on many fronts to take over as the new centre for gold trade when the western (paper) gold markets collapse.
The Chinese have, through designing a sound physical market place with the Shanghai Gold Exchange, laid the groundwork for putting gold in the hands of the people.
By clearly separating paper trading from physical trading, the Shanghai Gold Exchange offers everyone the opportunity to buy physical gold directly from the exchange.
After a brief period of increased transparency where it for a while seemed that the Chinese wanted to advertise their market setup to the rest of the world, China now seems to have come to the conclusion that too much transparency around their immense accumulation of gold may have negative repercussions and they have consequently ceased publishing figures for physical gold withdrawals at the Shanghai Gold Exchange. China thus seeks to accumulate gold but doesn’t want to communicate it openly.
At the same time, the London Bullion Market Association (LBMA) and the World Gold Council (WGC), which are constructed to develop and support the gold industry, resort to protect their stakeholders, the bullion banks, by upholding the opaqueness of the gold price auctions and changing data retrospectively.