In December 2016 Chinese wholesale gold demand, measured by withdrawals from the vaults of the Shanghai Gold Exchange (SGE), accounted for 196 tonnes, down 9 % from November. December was still a strong month for SGE withdrawals due to the fact the gold price trended lower before briefly spiking at the end of the month, and the Chinese prefer to buy gold when the price declines (see exhibit 1).
In total Chinese wholesale gold demand reached an astonishing 1,970 tonnes in 2016. But will these huge tonnages bought by China ever have an impact on the gold price? I think it will.
As in previous years, SGE withdrawals were mostly supplied through imports, in 2016 at approximately 1,300 tonnes. And as in previous years, SGE withdrawals were roughly twice the size of Chinese consumer gold demand. The latter is published by all “leading” consultancy firms, such as the World Gold Council and Thomson Reuters GFMS. Because these firms have systematically underreported and eclipsed Chinese gold demand since 2007, a significant share of the financial industry is unaware China has imported 5,000 tonnes in the past years, which is not allowed to be exported. My hypothesis is that this 5,000 tonnes decline in above ground gold reserves outside of the Chinese domestic market will make gold rally stronger in a future bull market than it did in previous bull markets. To the extent many investors are uninformed about the shrinking volume of troy ounces available outside of China, their ignorance will boost any price rally coming.
In this post I would like to share my thoughts on how the gold price is correlated to trade in above ground reserves, and how China has slashed these reserves to the tune of 5,000 tonnes, which will significantly impact the next leg up in gold.
Correlated: The Gold Price And UK Gold Trade
Since many decades large investors in the West set the price of gold. Ever since, the heart of the Western gold wholesale market has been London in the United Kingdom. There is thus a correlation between the gold price and the volume of gold net imported or exported by the UK.
In Asia, on the other hand, gold market participants are more price sensitive, implying they buy low and sell high (the opposite of Western investors). I’ve described this trend frequently on these pages, but the same can be read in books by gold author Timothy Green. In The Prospect For Gold from 1987 Green states:
Before we discuss the connection between Western supply and demand trends to developments in the Chinese gold market of the past decade, let me first recapitulate that global physical gold supply and demand is far in excess of the statistics the World Gold Council and GFMS publish. Below is a chart that shows the quarterly averages of all physical supply and demand categories as disclosed by the World Gold Council from Q1 2002 until Q4 2015. These numbers are more or less the same as figures by GFMS.
We can see that over the course of 13 years, the majority of supply consisted of mine output (73%) and the majority of demand consisted of jewelry consumption (64%).
(Note, the categories official sector, net producer hedging and ETFs can be either supply or demand and volumes can greatly vary per quarter. Though, only in 1 of 52 quarters examined has ETF demand been greater than jewelry consumption (Q1 2009). In all other quarters official sector, net producer hedging and ETFs supply or demand has not been greater than mine output or jewelry consumption.)
If the data by the World Gold Council regarding physical gold supply and demand would be exhaustive, mine output and jewelry consumption should have a positive correlation to each other and the price of gold. But they don’t. Have a look at the next chart.
During the bull market from 2002 until 2011 jewelry consumption decreased and it hardly ever transcended mine output. In turn, mine output gradually ascended over this time horizon while the gold price increased six fold! Are the forces between jewelry demand and mine supply driving the medium/long term price of gold? No, clearly not. This shows the data by the World Gold Council is incomplete.
(I should add that mine output does have a correlation to the gold price in the very long term as it can take more than ten years to setup a gold mining project. See the next chart.)
In contrast to the data by the World Gold Council, we can observe a strong correlation between the medium/long term gold price and institutional supply and demand flowing through London. View the chart below.
Strangely, institutional supply and demand are categories not included in the World Gold Council’s data – or in any other precious metals consultancy firm’s data that I’m aware of.
Because in the UK there are no refineries, no gold mines and local consumption demand and scrap supply is immaterial, all gold that is visibly (non-monetary) imported and exported must either relate to ETF holdings stored in London, or Western institutional supply and demand. When we compute the ratio between both, ETF flows compound to roughly 35 % of the UK’s net flow (import minus export) and as a consequence approximately 65 % is Western institutional supply and demand. Effectively the majority of the UK’s net flow is Western institutional supply and demand.
Hereby, consider that all supply and demand categories disclosed by the World Gold Council more or less equal each other (exhibit 4), so for the sake of simplicity we‘ll state that total mine output + scrap supply versus jewelry consumption + bar and coin + industrial demand meets outside the UK and doesn’t set the medium/long term price of gold.
The UK’s net flow, on the other hand, is highly correlated to the medium/long term price of gold. Note how nearly every month the change in net flow corresponds with the direction of the gold price (exhibit 6). Less granular, from the moment my data starts in 2005 the UK has been a net importer until 2012 on a rising price of gold. From 2013 until 2015 the UK was a net exporter on a declining price of gold. And in the first quarter of 2016, when the gold price saw its strongest move up since 1986, the UK was a net importer. Coincidence? I think not.
We can conclude that Western institutional supply and demand in above ground gold reserves is driving the medium/long term price of gold. As it’s likely the price of gold could not have gone up from 2002 until 2011 if there had been no UK net imports, and it’s likely the price of gold could not have gone down from 2013 until 2015 if there had been no UK net exports. (Short term the gold price is pushed around in the paper markets.)
We can think of Western institutional supply and demand (the UK net flow) like this: the majority of the gold gross imported into the UK is demand from above ground reserves outside the UK, and the majority of the gold gross exported from the UK is supply to above ground reserves outside the UK. When the UK is a net importer that means there is a net pull on above ground reserves outside the UK, which corresponds to a rising gold price. When the UK is a net exporter the inverse is true.
Here it becomes apparent that the amount of above ground bullion is essential for future price developments.
The Chinese Black Hole
Let’s turn to China. In the introduction I stated China is importing a lot more gold than is known in the financial industry because most investors base their knowledge on data by the World Gold Council. More precise, China has imported 5,000 tonnes from 2007 until 2016 in addition to what the World Gold Council has portrayed through their demand statistics.
Let’s get our minds around this through some charts. As an example, I’ve drawn a chart showing Chinese gold supply and demand for 2015 (last year I have complete data of).
We don’t know every exact data point for China, but we do know GFMSdemand (purple) and apparent supply, consisting of domestic mine output (green), scrap supply (yellow) and net import (blue). From here on we’ll use GFMS data, as GFMS publishes scrap supply numbers for China and the World Gold Council doesn’t.
According to GFMS Chinese consumer gold demand in 2015 was 867 tonnes. To meet demand GFMS presents 450 tonnes was domestically mined and scrap supply accounted for 225 tonnes. Indirectly GFMS states China net imported 192 tonnes to complete the supply and demand balance in the Chinese domestic market (exhibit 7). For the additional 1,383 tonnes imported GFMS has floated all sorts of excuses, which I‘ve debunked here and here.
The bottom line is, in addition to the 192 tonnes GFMS reports as imported in 2015 to meet consumer demand, China imported 1,383 tonnes to meet institutional demand and all this metal is not allowed to be exported.
If we repeat the same exercise for every years since 2007, the aggregated net imports by China that have not been included in the statistics by GFMS account for 5,000 tonnes. See the next chart.
You can see now, China has enormously diminished above ground reserves outside of the Chinese domestic market without all investors around the world being fully aware. In my humble opinion this will make the price of gold go up turbo charged next time the West shows interest in the metal.
In The Prospect For Gold Green states:
“Selling gold is not a one way street”, wrote Green in 1987. But guess what. Since a few years – from the moment China became an elephant player in the physical market – selling gold is a one way street! Western sell-offs are transhipped to China but do not return. The global gold game has changed.
The consequence is that there are less above ground reserves outside of China for Western investors to buy in a forthcoming bull market, which will elevate the dollar bid per unit gold – in other words the gold price measured in US dollars per troy ounce.
Keep in mind, this phenomenon (China importing vast quantities in addition to Chinese consumer gold demand as disclosed by GFMS) has greatly materialized in 2013, when gold entered a bear market after an 11-year run up. In the previous bull market (2002-2012) above ground reserves outside of China had not been slashed yet. So the ramifications of this phenomenon will only be felt during the next leg up.
Is there any proof to substantiate my hypothesis? I think so. Early 2016 there was some renewed interest in yellow metal from large Western investors. When the price of gold started to climb it went practically vertical ending the first quarter of 2016 up 16.7 %, the strongest quarter since 1986. Coincidence? I think not. It went up strong as it did because there were fewer ounces in above ground reserves available.
A study on how much above ground reserves there are outside China will be saved for a future blog post.
Last week the Shanghai Gold Exchange (SGE) launched a new English website to offer international customers more information and tools on trading gold in renminbi through its subsidiary in the Shanghai Free Trade Zone the Shanghai International Gold Exchange (SGEI). BullionStar took the opportunity to translate a speech by a Teng Wei, Deputy General Manager of the SGEI, named “How China’s Gold Market Can Help The RMB Achieve International Status” that was held at the Renminbi World summit in Beijing on the 29th and 30th of November 2016. In the speech Teng Wei outlined his vision for the SGEI going forward regarding renmibi (RMB) internationalization, connecting the onshore and offshore renminbi market and increasing gold market share.
My comment before you read the translation:
1) In the financial blogosphere the general perception is that the SGEI has been a failure since it was launched in September 2014. This analysis is based on the assumption that the trading volume of the most popular SGEI contract (1 Kg 9999 – iAu99.99) has been tepid for two years now. But this analysis neglects two important elements.
First, iA99.99 can be traded competitively “on Exchange”, but also in the OTC market. The OTC possibility is hardly known by commentators in the English world, though the related volumes are significant. Have a look at the next chart in which I’ve plotted iAu99.99’s weekly trading volume “on Exchange” and in the OTC market. Clearly iAu99.999 is traded mainly in the OTC market.
Second, international customers of the SGEI can not only trade the SGEI gold contracts, but they can also trade SGE (domestic) gold contracts. Logically, as at present liquidity on the SGE is much higher than on the SGEI, many international customer that seek to trade gold in renminbi, and don’t need to export the metal, will choose to trade SGE gold contracts.
When observing total trading of all SGE(I) gold contracts, there is a clear rise in volume since the SGEI was launched.
Up till now international customers are mainly trading SGE contracts. The significant rise in trading volume of all SGE(I) contracts since September 2014 is due to the inception of the International Board (SGEI). In the second week of November 806 tonnes was traded on the SGE(I), the highest amount ever.
So the launch of the SGEI has not been a failure in my opinion – it has elevated gold trading in (offshore) renminbi.
2) Teng Wei mentions that in 2015 gold demand in China and India was 985 and 849 tonnes respectively. In the case of China this refers only to consumer demand, not institutional demand. Chinese consumer and institutional demand in 2015 combined was well north of 2,000 tonnes.
3) A gold exchange doesn’t flourish overnight. The SGE was launched in 2002; in that year its total trading volume was 22 tonnes and withdrawals accounted for 16 tonnes. Ten years later total trading volume was 3,175 tonnes and withdrawals accounted for 1,138 tonnes. In 2015 total trading volume was 17,033 tonnes and withdrawals accounted for 2,582 tonnes. The development of the SGE, becoming the largest physical gold exchange globally, took time and it can be no different for the SGEI.
Document Translation [brackets added]:
Teng Wei: China’s Gold Market Opens Up To Boost RMB Internationalization
The 2016 RMB summit was held in Beijing on the 29th and 30th of November. Deputy General Manager of the Shanghai International Gold Exchange Center Teng Wei participated in the forum and discussion on “How China’s Gold Market Can Help the RMB Achieve International Status”. He expressed that using Shanghai’s free trade zone status, investors can open trading accounts denominated in RMB and participate in trading directly through the Exchange’s international board [SGEI] that allows access to most of the precious metal products that are traded in China. The international board has developed relatively well since establishment with active participation from international members and steadily increasing trading volume.
Gold on the international board is quoted and settled in RMB, which effectively connects the RMB onshore market and offshore market. This will extend the scope of RMB usage across borders and provide a new channel for inward capital flows. It is a move that is beneficial to expand the RMB usage to steadily promote internationalization of the RMB.
The actual speech:
Ladies and gentlemen, good afternoon, I am Teng Wei from the Shanghai International Gold Exchange. I am delighted to participate in this forum organized by the Asian Bankers Association to have a chance to speak and interact with everyone about opening China’s gold market to the world and how that can help the internationalization of the RMB.
This afternoon, I would like to touch upon on three topics. The first topic is the new pattern of the internationalization of the RMB and the global gold market. China’s gold market was established in 2002 with the launch of the Shanghai Gold Exchange. If anyone is familiar with the history of China’s gold market, you will know that before the year 2002 the Chinese gold market was entirely ran by the People’s Bank of China, including the process of purchasing, allocating and storing of gold. There wasn’t a single unified market where all participants could trade at the same time. Since the year 2002, with approval of the State Council, the People’s Bank Of China developed gold spot trading on the Shanghai Gold Exchange, as well as gold futures trading and over-the-counter trading via commercial banks, etc, which formed the basis for a multi-level diversified gold market system. While the Chinese gold market was developing rapidly, the pattern of the global gold market was also having a dramatic change. As time passed, the international gold spot market was heavily concentrated in London and the international gold futures market has been concentrated in New York. However, in recent years, with the rise of gold demand in China, India and other Eastern nations, and with the exit of European and American banks from the precious metals market, it’s clear that Western gold is moving to the East. In 2015 gold demand in China and India was at 985 tons and 849 tons respectively. These figures alone account for 45% of global [consumer] gold demand. With gold demand from other markets dipping to various levels, China is not only the world’s largest gold producer and importer of gold, but has also become the world’s largest gold consumer.
Just now, I mentioned that the two main centers for gold trading are London and New York, and the current situation is Western gold flowing to the East. Everyone, have a look at some statistics that I have here, showing that just China and India alone make up over 45% of global gold demand. This was last year’s data.
Since the year 2005, when the RMB exchange rate was reformed, international investors’ willingness to trade in RMB denominated assets has also increased. This has objectively enhanced the Chinese gold market’s international status and garnered attention. In recent years, the RMB exchange rate is expected to have some changes.
The Shanghai Gold Exchange provides the important infrastructure for China’s gold market. ECB officials have mentioned that an important part of promoting the internationalization of the RMB is having a good financial market infrastructure. The exchange is also an important “all-in-one” foundation for gold transactions, clearing, delivery and storage. It serves with the commitment to provide gold investors with efficient and convenient market services. It has been 14 years since establishment of the exchange in the year 2002 and development has been rapid with annual trading volumes increasing 40% on average.
At the end of 2015 there were over 8.6 million individual accounts, over 10,000 institutional accounts and the total gold trading volume for the year reached 17,000 tonnes. The exchange was ranked as one of the largest and we firmly grasped an important opportunity for the internationalization of the RMB with the profound changes happening in the gold market. At the same time, we want to build a harmonious ecological gold market that sets a new path for the global gold market and achieve the status of being a global gold power from a large gold holding nation.
For the second point, I would like to explain how opening up China’s gold market externally to the world can help the internationalization of the RMB. To further promote and innovate China’s gold market, on 18th September 2014, the Shanghai Gold Exchange set up an international board [SGEI], open directly to foreign investors. This move has effectively connected China’s domestic gold market and the international gold market. Using Shanghai’s free trade zone, investors can open trading accounts denominated in RMB and participate in trading directly through the exchange’s international board that allows access to most of the precious metal products that are traded in China. The international board has developed relatively well since establishment with active participation from international members and steadily increasing trading volume.
As of now, the exchange has 67 international members, including most of the world-renowned gold suppliers and traders like Mr Thomas McMahon, who is also our Exchange’s member. At the end of the third quarter of 2016, the international board had recorded a total of 7,837 tonnes of gold traded, with a turnover valued at nearly 200 billion RMB. The Shanghai International Gold Exchange is the test pilot and pioneer for opening up China’s gold market to the world. It is significantly important for further increasing the capacity, expansion and international influence of China’s gold market. In addition, the international board uses RMB for settlements, producing an effective convergence of the RMB offshore and onshore markets, expanding the cross-border use of the RMB and providing a new channel for return of funds. All these points steadily promote the internationalization of the RMB and serve as a useful exploration.
For RMB denominated gold products to gain popularity outside of China, we think the prerequisite is to provide a fair offering for global gold market transactions, with reliable gold benchmark pricing in RMB, using the Shanghai Gold Exchange benchmark pricing mechanism [Shanghai Fix] for our trading platforms. The weight of the gold traded is 1 kilogram, with a fineness of no less than 99.99%. Using a price inquiry method and market volume, a balance is reached to form the benchmark price of gold measured in RMB. The price announcements will be released externally each trading day at 10:15 and 14:15.
At present, the Shanghai gold benchmark price is being used by domestic gold producers and suppliers for hedging and settlements. More and more commercial banks are also using the Shanghai gold benchmark price for gold leasing and financing as the standard. More and more products linked to the Shanghai gold benchmark will be made available.
Other than domestic usage, the Shanghai gold benchmark price is also being actively studied more and more by external markets regarding its application. In October, the exchange signed an agreement with Dubai for the right to use the Shanghai gold benchmark price and authorization was given for the Dubai gold exchange to use the Shanghai gold benchmark price as the standard for offshore RMB denominated futures. The signing of this agreement marks the use of the Shanghai gold benchmark price in international financial markets for the first time. This greatly helps to elevate the international influence of the exchange in global markets and improves the image and reputation of the RMB abroad.
For the third point, I would like to share with everyone how the Shanghai Gold Exchange acts as an important infrastructure for internationalization in three steps. As the forerunner for opening domestic markets and innovation, the Shanghai Gold Exchange cannot forget its historical mission. We are determined to take the international and market-oriented strategy.
Overall, for the internationalization process, we have three steps to take. The first step is to be open and inclusive, actively inviting foreign investors to come in. Just now, we have introduced our international board after the establishment of the Exchange and we will continue to increase publicity efforts. In accordance to high standards and multifaceted principles, we will continue to increase and expand international membership of the Exchange. Accordingly, we have carried out a variety of promotional activities in major financial hubs and countries and regions along the new Silk Road to allow more international market participants to hear the sound coming from the Chinese gold market. The exchange also takes the opportunity to actively learn from the experience of advanced international markets in the optimization of various trading systems and innovation of all kinds of trading products.
For the second step, since we have invited guests inwards, we also have to step outwards. Through cooperation and win-win situations, the gold Exchange can be promoted and step out of China. The Shanghai gold benchmark price has now taken a first step with the Dubai Gold Exchange agreement. This can be considered an ice-breaking move and serve as a cooperation model for other overseas markets and improve the recognition, branding and acceptance of the Shanghai gold benchmark price. Taking this as an opportunity, the Shanghai Exchange, together with the Chicago Mercantile Exchange (CME, COMEX), the Hong Kong Stock Exchange, the Malaysian Stock Exchange and a number of foreign exchange markets explored on long-term cooperation mechanisms that will allow foreign investors to directly participate in our gold market, in RMB denominated gold trading, standard gold settlement, and many other aspects and modes of cooperation that will increase the Shanghai Gold Exchange’s international market influence.
The third step is to realize RMB internationalization and increase global transaction on the exchange through integration and upgrades. As the international financial markets continue to merge and develop, market boundaries are increasingly blurred and we believe that market fragmentation will be removed gradually. In recent years, we can all notice that there are more and more mergers and acquisitions among major exchanges in the world. We hope to learn from the experiences of such joint stock mergers and acquisitions between global exchanges and explore the different modes of industry integration with overseas exchanges. By offering a wide range of local and overseas products through an open platform [SGEI], we hope to create a world class exchange group. The journey of the internationalization of the Shanghai Gold Exchange will epitomize the opening of China’s financial markets to the outside world and play an important part in the internationalization of the RMB. With Shanghai becoming the third most important market in the world after London and New York, the Chinese gold market will make a great contribution to the internationalization of the RMB. Thank you everyone.
From the moment Donald J. Trump got elected as the next President of the United States, on November 8, 2016, the price of gold tumbled 8 % in the remainder of the month – from $1,282 USD/oz to $1,178 USD/oz. Usually these cascades in the gold price go hand in hand with physical sell-offs in the West and strong demand Asia. It appears November has been no exception. The volume of physical gold withdrawn from vaults of the Shanghai Gold Exchange (SGE) in November accounted for 215 tonnes, the highest amount in ten months. Year to date SGE withdrawals have reached 1,774 tonnes.
There have been rumours in the gold space about the People’s Bank Of China (the PBOC) curbing gold import into the Chinese domestic market in response to capital flight. Although my sources have confirmed these rumours, Chinese gold import in November was still very strong at an estimated 140 tonnes. I don’t expect the PBOC will halt gold import all together.
The first mention of the rumour was by Reuters on November 25. By then the premium on physical gold trading at the SGE, which more or less reflects the strength of local demand versus international supply, had reached 2 % (from ~ 0.2 % on November 1). Reuters wrote:
“While we don’t have the exact numbers, we hear that they (Chinese government) have limited the number of importers,” said Dick Poon, general manager at Heraeus Precious Metals in Hong Kong.
In a previous blog post I stated the quote from Poon was not likely to be accurate, because there are 15 banks that have PBOC approval to import gold, but for every shipment a new License must be requested at the central bank. This protocol is referred to as “one batch one License”. Bullion cannot cross the Chinese border without a License. From the PBOC:
There shall be one Import … License of the People’s Bank of China for Gold … for each batch … and the License shall be used within 40 work days since the issuing date.
If the PBOC desires to curb gold import it can simply hand out less Licenses to approved banks, instead of deleting banks from the approved list. The former has happened as far as I can see. The next mention was by the Financial Times on November 30 [brackets added]:
Some banks with licences [approval] have recently had difficulty obtaining approval [Licenses] to import gold, they said — a move tied to China’s attempts to stop a weakening renminbi by tightening outflows of dollars, the banks added.
Although the Financial Times exchanged the terms “approval” and “License”, this is what I thought that was happening: banks are obtaining less import Licenses from the PBOC, which is obstructing supply, pushing up the SGE premium.
Either way the PBOC effort has not severely impacted the volume of Chinese gold demand as SGE withdrawals set a ten-month record at 215 tonnes in November, up 40 % from October. Premium or no premium the Chinese still ‘accumulate on the dips’. Additionally, mainlanders buy gold in Hong Kong where jewelry is cheaper as it doesn’t enjoy VAT. From Live Trading News we read:
“Gold sellers in Hong Kong, where mainland Chinese often buy gold, report an increase in purchases, …” according to published reports. “Some of the buying is also because of the Lunar New Year period next month, a time when buying normally picks up.”
How much of SGE withdrawals were supplied by import? Let’s make an educated guess. In the first nine months of 2016 SGE withdrawals accounted for 1,407 tonnes and China net imported 908 tonnes over this period, implying 65 % of SGE withdrawals was imported. If we use the past months as a reference China imported 140 tonnes of gold in November (=0.65*215). Year to date (-November) China has imported and estimated 1,147 tonnes.
An other possibility would be that elevated SGE withdrawals in November were supplied by scrap and disinvestment from within China (domestic mine output is fairly constant at 38 tonnes per month). Though this is not very plausible because the renminbi gold price went down in November (red line in exhibit 1). Normally scrap supply increases on a rising gold price. And hence, I assume the majority of SGE withdrawals in November were supplied by imports.
There have been concerns in the gold community with respect to a full stop on Chinese gold import. In my humble opinion the PBOC will not completely block imports for a number of reasons:
Despite the rumours of obstructed imports SGE withdrawals were strong in November.
The PBOC hasn’t released an official statement to curb imports.
The PBOC has just spent decades to develop the Chinese gold market in order to strengthen the Chinese economy and internationalize the renminbi. Why cancel the project for problems that can be solved differently?
Curbing gold imports would improve China’s current account. But China has a current account surplus; the capital account is in deficit. Why doesn’t the Chinese government tighten the capital account? In Q3 2016 China’s capital flow was minus 71 billion US dollars. In the same quarter gold import was valued at an estimated 13 billion US dollars. The problem is in the capital account.
SGE premiums started to rise on November 8 exactly when the gold price went down (which SGE premiums often do when the price goes down, exhibit 5). So are these elevated premiums of late fully caused by curbed imports, or simply strong demand? It’s probably a mix of both; in any case there is no full stop on imports. What probably happened is that imports exploded when the price tanked after November 8. As a result the PBOC decided to block shipments.
Most gold analysts surmise COMEX 100-ounce gold futures contracts (GC) can only be physically settled through taking and making delivery. This is technically true when excluding the possibility of EFP trading in GC through the over-the-counter (OTC) market. While on Exchange trading in GC is “executed openly and competitively”, trading GC in the OTC realm (and thus the price of the gold, its form and location) is a “privately negotiated transaction” between buyer and seller. The COMEX is a subsidiary of CME Group, which offers its clients OTC trading on a platform called ClearPort.
Because the COMEX in New York is the most liquid gold futures exchange globally – offering precious metals futures denominated in the world most used currency the US dollar, gold industry participants use GC for a variety of reasons, including hedging metal held outside the contract’s deliverable geography. Subsequently, the contracts can be physically “settled” anywhere at any price through EFP.
In EFP two parties sign a futures contract (short and long) and simultaneously execute a reverse spot transaction (buy and sell). One side sells short the futures contract and buys spot gold (the spot leg is referred to as the related position by CME), while the other buys long the futures contract and sells the related position. EFP trading can increase the open interest, decrease the open interest, or not change it, depending on the existing positions held by both parties before they enter into an EFP transaction. When EFP decreases the open interest the phrase “settle positions” is applicable. Another way of saying it would be “offsetting positions” or “netting out positions”.
This example matches my previous one regarding EFP (hedging metal held outside the contract’s deliverable geography). Any bullion bank, miner or refinery can sell short on COMEX and when the gold needs to be physically “settled”, for example in Switzerland, the short position can be unwound through EFP. The only requirement is that “the quantity of the related position component … must be approximately equivalent to the quantity of the Exchange component” – meaning the spot leg must be more or less 100-ounces of gold, which is the underlying asset of GC. In this example the GC short holder connects through CME ClearPort to Exchange For Physical. In the EFP transaction he will buy long a futures contract and simultaneously sell spot. His long and short will then be netted out while he sells spot the physical in Switzerland. Effectively, a COMEX short has been physically settled outside the contract’s deliverable geography. Naturally, a long position can also be unwound in Switzerland, which is then the other side of the trade.
EFP Moves Kilobars Through CME’s Hong Kong Vaults
In March 2015 CME launched a Gold Kilo Futures contract (GCK) physically deliverable in Hong Kong, but ever since implementation there has been poor participation in this instrument. From the start GCK trading volume has been close to nothing and deliveries rarely occur. Notwithstanding, there are massive volumes of kilobar gold flowing through the CME approved warehouse in Hong Kong owned by Brink’s, Inc.. On average 3.9 tonnes per day are withdrawn from this vault, but sometimes daily withdrawals are as high as 20 tonnes.
Because volume and delivery for GCK on Exchange is so low, the withdraws must be explained by OTC trades. A CME representative actaully confirmed this to me; the physical movement through the Hong Kong vaults is caused by EFP transactions.
But if we look at the GCK volume page we can never observe any EFP trades being disclosed. In contrast, EFP volume of GC is substantial. Can it be gold kilobars in CME’s approved warehouses in Hong Kong are used to settle the 100-ounce futures contracts? Yes.
My theory is that kilobars bought by bullion banks in the West, for example at Swiss refineries, to be consigned to China are hedged on the COMEX and once the gold arrives is Hong Kong the shorts are unwound through EFP. From there the gold is transported by armored truck to Shanghai Gold Exchange designated warehouses in Shenzhen by Brink’s that has a cross-border logistics license from the Chinese government. Supportive to my theory, see exhibit 3 below. Notice the strong correlation between “gold import into Hong Kong versus kilobars received in CME’s vaults” and “re-export from Hong Kong versus kilobars withdrawn from CME’s vaults”.
The correlation points out most gold moving through Hong Kong, which is headed for China, is in kilobar form and moves through CME’s vaults. And because most of this throughput is EFP related, I assume the kilobars are used to settle COMEX futures.
It’s hard to test if my theory is accurate because EFP transactions are executed in the OTC realm and little information is available. Possibly, al throughput in Hong Kong is EFP related but doesn’t impact the GS open interest. If anyone has a different theory please comment below.
London Gold Offsets COMEX Futures
We’ve established gold in Switzerland and Hong Kong is used to “settle” gold futures. But there is also proof gold in London is used to phase out positions on the COMEX. When researching this topic I reached out to William Purpura who is, inter alia, Chairman at Northport Commodities, member of the COMEX Governors Committee, and previously traded on the COMEX floor from 1982 to 2007. I asked Purpura for an example of how EFPs are used. He replied [brackets added by me]:
Most of it [EFP] is done by bullion banks. … It’s mainly for netting out. Lot’s of times London versus New York. You see lots of EFPs posted around 8am in New York on COMEX.
There it is, “London versus New York”, and, “netting out”. From this quote we learn loco London gold is used to execute EFPs to wash out New York futures positions. One can argue the related position in London is “unallocated” – I’m not sure. In the latest formulation by CME on EFP (Market Regulation Advisory Notice RA1311-5R) it’s stated:
Where the related position component … is a physical transaction … the transaction should be submitted for clearing as an EFP transaction type.
Often in wholesale gold market parlance physical is also used for “unallocated gold”, which is not exactly physical in my opinion.
I’m sure there are many more methods than I’ve mentioned to use EFP, or any other privately negotiated transaction (PNT) available on ClearPort, that influences the open interest at the COMEX. One thing is for sure, conventional delivery is not the only way to terminate futures positions. In the gold futures rulebook this is explicitly noted by CME Group. The excerpt below is about terminating a gold futures contracts [brackets added by me].
113102.E. Termination of Trading
No trades in Gold futures deliverable in the current month shall be made after the third last business day of that month. Any contracts remaining open after the last trade date must be either:
(A) Settled by delivery which shall take place on any business day beginning on the first business day of the delivery month or any subsequent business day of the delivery month, but no later than the last business day of the delivery month.
(B) Liquidated by means of a bona fide Exchange for Related Position [/EFP] … .
This is important for our comprhension of the global paper and physical gold market. COMEX gold futures delivery statistics are not all there is to it.
Core Supply & Demand Data Chinese Gold Market Q1-Q3 2016
Chinese gold demand is still going strong this year, albeit less than in 2015. The most likely reason for somewhat lower demand has been the strength in the price of gold in the first three quarters of this year, to which the Chinese reacted by subduing purchases. From 1 January until 30 September 2016, the gold price went up 24 % in US dollars per troy ounce, from $1,061.5 to $1,318.1; measured in renminbi the price went up 28 % over the same period.
Now I have proven the gold on Chinese commercial bank balance sheets has little to do with physical gold ownership of these banks, but mainly reflects back-to back leases and swaps, we can be positive that data on withdrawals from the vaults of the Shanghai Gold Exchange (SGE) roughly equals Chinese wholesale demand. For now that is, as future developments can always alter our metrics.
Below is a chart showing withdrawals from the vaults of the SGE and the price of gold in yuan per gram. The most significant trends of recent years are still in effect; in the short term, when the gold price is falling Chinese demand increases (2013 and 2015), when the gold price is rising Chinese demand declines (2016). This trend is supported by SGE premiums that have an inverse correlation with the price of gold, when the price of gold declines, SGE premiums escalate and vice versa – I will show charts below. Furthermore, in the long term we can observe consistent growth in Chinese gold demand due to the opening up and development of the domestic market.
SGE withdrawals in the first three quarters of 2016 accounted for 1,406 tonnes – still impressive – down 29 % from 1,986 tonnes in 2015, which was a record year. Annualized SGE withdrawals are set to hit 1,877 tonnes in 2016.
Notable, “known net import” by China is relatively strong compared to SGE withdrawals in 2016. Total net import in the first three quarters of this year has aggregated to 905 tonnes – annualized 1,206 tonnes – or 64 % of SGE withdrawals, versus an import/withdrawals ratio of 53 % in 2015. As mine supply to the SGE is fairly constant, recycled gold through the SGE must be lower this year than last year. As a rule of thumb, we use the equation:
The largest net exporter to China is still Hong Kong, having transhipped 608 tonnes to the mainland from January until September 2016, up 5 % compared to 2015. The volume Hong Kong exports to the mainland has been quite constant since 2014, while in 2013 China’s special administrative region was a substantial larger supplier.
(There have been rumors that Hong Kong ’s export to China is overstated in the official data by the Hong Kong Census & Statistics Department, caused by fake exports. In the chart below you can see that the share of exports relative to re-exports from Hong Kong to China this year has increased from previous years. Potentially this signals fake exports, as it’s easier to over invoice an export than re-export, though I haven’t found hard evidence for this scheme. When I do I will report accordingly.)
The second largest exporter to China is Switzerland, having supplied a net 229 tonnes so far this year, which is 22 % more than last year. Clearly, direct shipments from Switzerland to China have replaced shipments via Hong Kong.
Direct net exports by the UK to China mainland have collapsed by 92 % this year compared to 2015, from 210 tonnes to a mere 18 tonnes. The reason being, the UK has been the largest net importer globally this year, which is related to the strength in the gold price early this year. UK net gold trade is a proxy for Western institutional supply and demand.
Australia’s direct export to China is down this year as well (in the first eight months, data for September has not yet been released). I’ve computed the data as described in my post Australia Customs Department Confirms BullionStar’s Analysis On Gold Export To China. Following this method, the land of down under has sent 50 tonnes of gold directly to China during the first eight months of this year, down 23 % from 65 tonnes in 2015.
Despite press releases suggesting Russian gold enterprises are strengthening ties with the SGE, I have identified only one shipment of 30 Kg by the Russian Federation directly to China in 2016. In 2013 the Russians directly net exported 50 Kg to China.
Data on gold export from South Africa to China is not publicly available.
Since 2014, when the Shanghai International Gold Exchange (SGEI) was erected, there is a possibility “SGE withdrawals” are inflated by withdrawals from vaults in the Shanghai Free Trade Zone; gold that is allowed to be exported abroad – the free trade zone is not part of the domestic market. But as far as I know any activity on the SGEI lacks foreign enterprises that buy gold to withdraw and export. A couple of months ago a source at a large Chinese bank told me the SGEI is mainly used by Chinese banks to import gold into Chinese domestic market. In addition, I haven’t bumped into any large importers from China. Occasionally India imports a few hundred Kg, but that’s it.
The emblematic difference between “Chinese gold demand as disclosed by GFMS” and SGE withdrawals – displayed in exhibit 7 – is due to GFMS’ incomplete metrics. For decades this consultancy firm has been denying the existence of institutional supply and demand in above ground gold, which is far more important to price formation than retail sales and mine supply, the predominant flows published by GFMS. The essence of this swindle can be read in my blog post The Great Physical Gold Supply & Demand Illusion. I also have a few more blog posts in the pipeline that discuss GFMS’ most recent gold supply and demand data.
I expect November to be a very strong month for SGE withdrawals. Mentioned in the introduction segment of this post, there is a trend in Chinese wholesale gold demand in relation to the gold price. Whenever, the gold price is climbing, Chinese demand is subdued, accompanied by low SGE premiums; when the gold price is decreasing, SGE withdrawals and premiums in China shoot up. The relationship between the gold price and SGE withdrawals can be viewed in exhibit 1. Below in exhibit 8 & 9, readers can see the relationship between “SGE end of day prices and premiums”.
Note, the gold price on the SGE and the premium have an inverse correlation.
I already mentioned that SGE withdrawals in the first nine months of 2016 have been subdued due to a rally in the gold price. However, high premiums at the SGE in November forecast elevated withdrawals for the month. Since Trump got elected on November 9, and price of gold started tumbling, SGE premiums have broken a three-year record. This signals strong demand.
In the next chart from Goldchartsrus.com we can see the premium on the SGE’s most traded physical contract Au99.99 has risen since November 9 and reached 3 % by 24 November. Levels not seen since 2013 (exhibit 8).
Although the relationship between the gold price and SGE premiums has been in place for years, Reuters reports the high premiums in November are caused by worries on import restrictions. From Reuters:
Gold premiums in top consumer China jumped to the highest in nearly three years this week on worries over a supply shortage that traders said were due to Beijing’s efforts to restrict import licenses.
“While we don’t have the exact numbers, we hear that they (Chinese government) have limited the number of importers,” said Dick Poon, general manager at Heraeus Precious Metals in Hong Kong.
To me this statement doesn’t make sense. At this moment that are 15 banks approved by the PBOC to import gold. Limiting the number of importers would cause less importers to import more gold in order to balance the domestic market (supply gold from abroad when necessary). In the Measures for the Import and Export of Gold and Gold Productsdrafted by the PBOC in March 2015 it states:
… An applicant for the import … of gold … shall have corporate status, … it is a financial institution member or a market maker on a gold exchange [SGE] approved by the State Council.
… The main market players with the qualifications for the import … of gold shall assume the liability of balancing the supply and demand of material objects on the domestic gold market. Gold to be imported … shall be registered at a spot gold exchange [SGE] approved by the State Council where the first trade shall be completed.
The Chinese government could lower imports by distributing less “import licences” to approved banks. As, every approved bank still needs to submit for a license for every gold import batch. Logically, lowering imports would be done by the PBOC through handing out less licences.
As readers might have seen on these pages, since 2014 I’ve been investigating the inventory audits of the US official gold reserves, which should proof the existence of the metal that embodies the credibility of the world reserve currency. My first article showed the official narrative: all the bars of in total 8,134 tonnes of gold spread over depositories at Fort Knox, West Point, Denver and New York, have been carefully counted, weighed, assayed and inventoried in between 1974 and 2008.
In subsequent posts I’ve exposed there is a vast array of problems to be found with the physical audits. Through several Freedom Of Information Act (FOIA) request, I had obtained information that severely damaged the integrity of the official narrative. Example given, one of my FOIAs that requested the audit reports drafted in between 1974 and 1986, when 7,504 tonnes was audited, revealed the US government had “lost” nearly all documents.
To get to the bottom of this I filed countless new FOIAs in the past months at the legal owner of the gold, the US Treasury, the custodian, the US Mint, and the head auditor, the Office Inspector General of the Treasury, in order to obtain every single piece of documentation I could think of that is related to these audits. Pretty soon, by putting all pieces of new information together I realized I was entangled in a conundrum of giant proportions as many documents contradicted each other. Eventually I submitted a request for a publicly unknown report, which I read about in a document I had obtained by another FOIA. I asked the Mint for “the [US Mint] Director’s Representative … written report to the [US Mint] Chief Financial Officer (CFO) notifying the CFO of the completion of the verification” for the years in between 1993 and 2008. Surprisingly, the US Mint wrote me my request would cost $3,144.96 dollars!
This amount of money is ridiculous. First of all, the documents should be readily available. Perhaps any digitalization costs would incur a few hundred dollars at most. Second, the Mint wrote the estimate of $3,144.96 dollars “includes 40 hours of … search time”. But how can it take 40 hours to find a few pieces of paper? It also wrote, my request would include an estimated 1,200 pages of documentation. But how do they know there are 1,200 pages if they first have to search 40 hours for it?
In any case, I decided to start a crowdfunding campaign last August to collect the money. After I tweeted about the campaign it quickly went viral. The news was spread on websites such as TFMetals, GoldMoney, GATA and GoldChartsRus – among others – and within a few hours the funding was completed, which shows to the power of our gold community.
After I received the money from the crowdfunding website I asked the US Mint for a bank account number to wire the funds. But the Mint replied I could only pay by check! Check? I was born in 1981, I have never seen a check in my life. Was this another way to obstruct my investigation? Most likely. It’s impossible the US Mint does not have a bank account, and every account has a number. I still can’t see why they don’t accept wired money.
But I had no option to go to a branch of my bank located in my area. When I walked in explained and the situation, the gentleman that helped me told me he never handled a check neither. This gentleman was replaced by an older one. There was a slight possibility he could create a check for me, but he had to look into it somewhat. Two hours later I walked out of his office carrying a promise the dollars would be transferred within a week.
A few days later the funds had been subtracted from my bank account, and I asked the US Mint for the first time (that was 11 September) if the check had arrived, but they replied it hadn’t. For weeks, mysteriously the check was “missing”. Only when I emailed the Mint with the email address of my local bank employee included, to have my bank and the Mint work it out together, the Mint confirmed on 28 September 2016 the funds had been received:
We have received your check and are now working to get the requested documents out to you.
That was 28 September, it’s now 15 November! I still haven’t received the documents from the US Mint. Naturally, I have sent more emails to ask what’s the status of my request, but no reply until now.
Or the Mint will have to confirm at some point they can’t deliver to me the paper work – maybe they got “second thoughts”. In that case they have to wire back the funds and I will have all funds send back to everybody that donated. Or they will honor my request in the coming weeks and I will include the findings in a very very long read I’ve been working on.
So, that’s all I know at this stage. Please have a little more patience. Thanks again everybody that donated. Either way, I will publish an article to reveal the results of all my FOIA and the many “problems” I found in the official narrative.
In the Netherlands we have a financial newspaper that prints on pink paper and is named “Het Financieel Dagblad”. Basically it’s the Dutch equivalent of the Financial Times. A few weeks ago I was interviewed by two of their reporters, Joost van Kuppeveld and Lenneke Arts. Today the interview was published as part of a series of interviews with gold experts, among others, with myself and Aerdt Houben, Director Financial Markets at the Dutch central bank (DNB). Perhaps not surprisingly I disagree with several statements of Houben in his interview, to which I would like to respond in a forthcoming post. For now, you can read my interview below. In case readers didn’t know my real name is Jan Nieuwenhuijs, and Koos Jansen is my Internet alias. Het Financieel Dagblad preferred to disclose my real name.
“The whole world is now in the same boat. Everywhere there are low interest rates and on all continents money is printed. Only the United States has paused printing for the moment.
There are many flaws in fiat money. You can print it without limitations, which is politically too tempting. Fiat money printing was used to save the financial system in 2008, but since then nothing has changed. Banks are not split. In a next crisis it’s going to end badly with paper money. There will be significant inflation.
Gold is a hard currency. It can’t be printed – like fiat money. It is divisible and it does not perish. It retains its purchasing power in the long term. If it’s in the center of the monetary system, it will also be more stable in terms of purchasing power in the short and medium term. That has to do with economic principles; it is a commodity. In that respect I feel safe by keeping a portion of my savings in physical gold. I am protected from economic shocks. If the euro falls gold rises, and so my purchasing power is maintained.
Something has to happen in the international monetary system. It cannot stay centred around the dollar. Since 1971 – when the dollar was detached from gold – the United States has an exorbitant privilege. Most trade in the world is settled in dollars. Therefore, there is a huge demand for dollars in the world, and the US can simply print these dollars.
In the new system gold is going play a role. Look at the developments in Europe. The Netherlands and Germany get their gold back from America. Austria and Belgium are also repatriating. Russia and China buy a lot of gold. The Chinese have too many dollars in foreign exchange reserves and are therefore at the mercy of the whims of US policy. The transition to a new system will be gradual. No one wants a new shock.
With my blog I try to fill the gap between mainstream media, who do not understand gold, and conspiracy theorists. I always try to seek the truth. Because if we get a new financial crisis, we must know the truth. The Dutch central bank shouldn’t state it holds 600 tonnes if it can’t show us the audit reports and gold bar list. That’s why I’m pushing for the audit reports and gold bars list to be publicly released, but those requests find a lot of resistance at my national bank. While you would think they can be fully transparent. What’s there to hide?”
Gold supply and demand data published by all primary consultancy firms is incomplete and misleading. The data falsely presents gold to be more of a commodity than a currency, having caused deep misconceptions with respect to the metal’s trading characteristics and price formation.
Numerous consultancy firms around the world, for example Thomson Reuters GFMS, Metals Focus, the World Gold Council and CPM Group, provide physical gold supply and demand statistics, accompanied by an analysis of these statistics in relation to the price of gold. As part of their analysis the firms present supply and demand balances that show how much gold is sold and bought globally, subdivided in several categories. It’s widely assumed these balances cover total physical supply and demand, which is incorrect as the most important category is excluded. The firms though, prefer not to share the subtle truth or their business models would be severely damaged.
The supply and demand balances by the firms portray gold to be more of a commodity than a currency, as the gist of the balances reflect how much metal is produced versus consumed – put differently, the firms mainly focus on how much gold is mined versus how much is sold in newly fabricated products. However, in reality gold is everlasting and cannot be consumed (used up), all that has ever been mined is still above ground carefully preserved in the form of bars, coins, jewelry, artifacts and industrial products. Partly because of this property the free market has chosen gold to be money thousands of years ago, and as money the majority of gold trade is conducted in above ground reserves. Indisputably, total gold supply and demand is far in excess of mine production and retail demand.
As most individual investors, fund managers, journalists, academics and precious metals analysts consider the balances by the firms to be complete, the global misconception regarding gold supply and demand is one of epic proportions. Physical gold is a profound anchor in our global financial system and thus it’s of utmost importance we understand the fine details of its trading characteristics.
Supply & Demand Metrics By The Firms
The firms can argue that the difference between what they present as supply and demand (S&D), as opposed to what I deem to be a more unadulterated approach of S&D is due to contrasting metrics. Accordingly, we’ll discuss their metrics to reveal their infirmity. In a nutshell, the firms only count the physical gold S&D flows that are easy to measure, while leaving out the most important part: institutional supply and demand.
Although the firms all have slightly different methodologies to measure S&D, from comparisons the numbers appear to be quite similar. For our further investigation we’ll spotlight the metrics and models by GFMS. The reason being, GFMS has been the only firm that was willing to share a full description of their methodology for publication – to be viewed here. Metals Focus (MF) provided a partial methodology, the World Gold Council and CPM Group declined to comment.
Let’s have a look at GFMS its S&D categories. On the supply side is included:
Mine supply (newly mined gold)
Scrap supply (gold sourced from old fabricated products)
On the demand side is include:
Jewelry demand (gold content used in newly manufactured jewelry products bought locally at retail level, adjusted by jewelry exported and imported).
Industrial demand (the volume of gold used in industrial applications, for example bonding wire, products used in semiconductors/electronics and dental alloys).
Retail bar investment (the net volume of bars that are purchased by individual investors through retail channels).
Coin investment (a combination of published data from mints and also a proprietary survey conducted by GFMS detailing where coins are sold).
The above four demand categories summed up are often referred to as “consumer demand” by the firms.
Furthermore GFMS includes:
Net hedging (change in physical market impact of mining companies’ gold loans, forwards, and options positions)
Net official sector (total central bank selling or buying)
ETF inventory build (change in ETF inventory)
Exchange inventory build (change in exchange inventory)
The last four categories can be either supply or demand. In example, when central banks (the official sector) in total are net sellers this will be listed as a negative demand figure, as is shown in the S&D balance by GFMS below from 2006 until 2009, when central banks in total are net buyers this will be listed as a positive demand figure, as is shown in the balance from 2010 until 2015. For a clear overview of the GFMS S&D balance please have a look at all line items below.
According to GFMS Supply consists of Mine production, Scrap and Net Hedging. In turn, Demand consists of Jewelry, Industrial Fabrication, Retail Investment, and Net Official Sector. After balancing Supply and Demand this results in a Physical Surplus/Deficit. Then, ETF Inventory Build and Exchange Inventory Build are added/subtracted from the Physical Surplus/Deficit to come to a Net Balance.
GFMS likes to pretend their balance is complete and occasionally articulates any surplus or deficit arising from it is positively correlated to the price of gold, which is anything but true, as I will demonstrate step by step.
The Firms Exclude Majority Gold Supply & Demand
Most important what’s excluded from the balance is what we’ll refer to as institutional supply and demand, which can be defined as trade in bullion among high net worth individuals and institutions. Usually the bullion in question comes in 400-ounce (12.5 Kg) London Good Delivery (GD) bars having a fineness of no less than 995, or smaller 1 Kg bars having a fineness of no less than 9999. In addition, bullion bars can weigh 100-ounce or 3 Kg, among other less popular sizes, generally having a fineness of no less than 995. Bullion can be traded without changing in weight or fineness, but it can be refined and/or recast for transactions as well, in example from GD bars into 1 Kg bars. In some cases institutional supply and demand involves cross-border trade, when bullion is sold in country A to a buyer in country B, in other cases the bullion changes ownership without moving across borders.
Provided are two exemplifications of institutional S&D:
An (institutional) investor orders 400 Kg of gold in its allocated account at a bullion bank in Switzerland – which would be purchased in the Swiss wholesale market most likely in GD bars. This type of S&D will not be recorded by GFMS.
A Chinese (institutional) investor buys 100 Kg of gold directly at the Shanghai Gold Exchange (SGE), the Chinese wholesale market, in 1 Kg 9999 bars and withdraws the metal from the vaults. Neither this transaction will be registered by GFMS – or any other firm.
These examples show the S&D balances by GFMS are incomplete.
For illustrational purposes, below is a chart based on all S&D numbers by GFMS from 2013, supplemented by my conservative estimate of institutional S&D. Including institutional transactions total S&D in 2013 must have reached well over 6,600 tonnes.
GFMS Covers The Tracks With Help From The LBMA
Although GFMS intermittently admits their number are incomplete (they have to), at the same time they’ve been battling for years to eclipse apparent institutional S&D for its audience.Dauntless tactics were needed when in 2013 institutional demand in China reached roughly 1,000 tonnes and over 500 tonnes in Hong Kong. Institutional demand in the East was predominantly sourced through GD bars from the London Bullion Market, which were refined into 1 Kg 9999 bars that are more popular in Asia. For the cover up GFMS went to great lengths to refute the volumes of gold withdrawn from SGE vaults, and accordingly have the London Bullion Market Association (LBMA) adjust statistics on total refined gold by its member refineries. Remarkably, the LBMA cooperated. Allow me to share my analysis in detail.
In 2013 something unusual happened in the global gold market as Chinese institutional demand exploded for the first time in history. Hundreds of tonnes of institutional supply from London in the form of GD bars were mainly shipped to Switzerland to be refined in 1 Kg 9999 bars, subsequently to be exported via Hong Kong to meet institutional demand in China. From customs data by the UK, Switzerland and Hong Kong the institutional S&D trail was clearly visible. From 2013 until 2015 there was even a strong correlation between the UK’s net gold export and SGE withdrawals. Demonstrated in the chart below.
Stunningly, since 2013 GFMS has tried to convince its readers through numerous arguments why SGE withdrawals crossed 2,000 tonnes for three years in a row, while Chinese consumer demand reached roughly half of this. Yet the arguments have failed miserably to explain the difference – they rationalize only a fraction, read this post for more information.
And GFMS did more to eclipse apparent institutional S&D. They colluded with the LBMA.
To be clear, I cannot exactly measure global institutional S&D. However, let me make an estimate of apparent institutional demand for 2013. Notable, in 2013 a flood of gold crossed the globe from West to East. Chinese institutional demand accounted for 914 tonnes and Hong Kong net imported 579 tonnes – the latter we’ll use as a proxy for additional Asian institutional demand, as Hong Kong is the predominant gold trading hub in the region.
In total apparent institutional demand in 2013 accounted for (914 + 579) 1,493 tonnes. If we add all other demand categories by GFMS shown in exhibit 1, total demand in 2013 was at least 6,619 tonnes. Be aware, this excludes non-apparent institutional demand.
Because nearly all wholesale gold demand in Hong Kong and China is for 1 Kg 9999 bars, the global refining industry was working overtime in 2013, mainly to refine institutional and ETF supply in GD bars coming from London. In December 2013 I interviewed Alex Stanczyk of the Physical Gold Fund who just before had spoken to the head of a Swiss refinery. At the time Stanczyk told me [brackets added by me]:
They put on three shifts, they’re working 24 hours a day and originally he [the head of the refinery] thought that would wind down at some point. Well, they’ve been doing it all year . Every time he thinks it’s going to slow down, he gets more orders, more orders, more orders. They have expanded the plant to where it almost doubles their capacity. 70 % of their kilobar fabrication is going to China, at apace of 10 tonnes a week. That’s from one refinery, now remember there are 4 of these big ones [refineries] in Switzerland.
As a consequence, statistics on “total refined gold production” in 2013 by “LBMA accredited gold refiners who are on the Good Delivery List”, which the four large refineries in Switzerland are part off, capture the immense flows of institutional S&D – next to annual mine output and scrap refining. On May 1, 2015, the LBMA disclosed total refined gold production by its members at 6,601 tonnes for 2013 in a document titled A guide to The London Bullion Market Association. It’s no coincidence this number is very close to my estimate on total demand (6,619 tonnes), as apparent institutional demand in Asia was all refined from GD into 1 Kg bars.
Here’s exhibit 2 from another angle.
In the table below we can see the LBMA refining statistics for 2013 at 6,601 tonnes.
After this publication GFMS was trapped; these refining statistics revealed a significant share of the institutional S&D flows they had been trying to conceal. What happened next – I assume – was that GFMS kindly asked the LBMA to adjust downward their refining statistics. First and painstakingly exposed by my colleague Ronan Manly in multiple in-depth posts, the LBMA kneeled and altered its refining statistics to keep the charade in the gold market going.
On August 5, 2015, the LBMA had edited the aforementioned document, now showing 4,600 tonnes in total refined gold production. (Click here to view the original LBMA document from the BullionStar server, and here to view the altered version from the BullionStar server.) Have a look.
In the altered version it says:
Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes (source Thomson Reuters GFMS).
A few important notes:
In the altered version the LBMA mentions “an estimate” for “total refined gold production”, while it doesn’t need to make an estimate as all LBMA accredited gold refiners who are on the Good Delivery List are required to provide exact data to its parent body. The exact data was disclosed in the first version of A guide to The London Bullion Market Association, and it stated, “total refined gold production by the refiners on the List was 6,601 tonnes”.
In the altered version the LBMA states the refining statistics were sourced from Thomson Reuters GFMS, but the LBMA doesn’t need GFMS for these statistics. The fact they mention GFMS, though, suggests a coordinated cover up of institutional S&D. Not only the firms, also the LBMA publishes incomplete and misleading data.
The altered version stated refining production totaled 4,600 tonnes, which is a round number and obviously quickly made up. A few weeks after the numbers were adjusted, the LBMA adjusted the numbers again, this time into 4,579 tonnes (click here to view from the BullionStar server).Clearly, on several occasions there has been consultation with the LBMA to get the statistics in line with GFMS.
In the original document the LBMA states, “Total refined gold production by the refiners on the List was 6,601 tonnes in 2013, more than double world mine production of 3,061 tonnes”, while in the altered version they state, “Total refined gold production by the refiners on the List was estimated to be 4,600 tonnes in 2013, owing to recycling of scrap material, above world mine production of 3,061 tonnes”. Notable, GFMS prefers to have total supply focused around mine and scrap production, instead of including institutional supply.
The original refining statistics (6,601 tonnes) are still disclosed in the LBMA magazine The Alchemist (#78 on page 24), to be viewed from the LBMA server here.
And so nothing is spared in trying to uphold the illusion of the GFMS S&D balance to be complete. In another example GFMS excluded gold purchases by the central bank of China from its S&D balance. In June 2015 the People’s Bank Of China (PBOC) increased its official gold reserves by 604 tonnes, from 1,054 tonnes to 1,658 tonnes. During that quarter (Q2 2015) all other central banks worldwide were net buyers at 45 tonnes. Thus, in total the Official Sector was a net buyer at 649 tonnes. Now, let’s have a look at GFMS’ S&D balance for Q2 2015:
Net Official Sector purchases are disclosed ay 45 tonnes. GFMS decided not to include the 604 tonnes increment by the PBOC simply because it didn’t fit their balance model. A 604 tonnes increment in would have set the “net balance” at -480 tonnes. Readers would have questioned the balance from this outlier, and so GFMS decided not to include the tonnage.
According to my sources PBOC purchases were sourced from institutional supply (from abroad and not through the SGE), which is a supply category not disclosed by GFMS and therefore the tonnage was a problem. (Note, GFMS disclosed the PBOC increment in text, but not in their balance.) For more information read my post PBOC Gold Purchases: Separating Facts from Speculation.
Gold Is More A Currency Than A Commodity
The biggest flaw of the balance model by GFMS is that it depicts gold to be more of a commodity than a currency. It’s focused on mine output and gold recovered from old fabricated products on the supply side, versus retail sales of newly fabricated products on the demand side. In parlance of the firms, how much is produced (supply) versus consumed (demand). Official sector, ETF and exchange inventory changes are then added to the balance. This commodity S&D balance approach by GFMS has caused deeply rooted misconceptions about the essence of gold and its price formation.
The price of a perishable commodity is mainly determined by how much is annually produced versus how much is consumed (used up). However, gold is everlasting, it cannot be used up and its exchange value is mainly based on its monetary applications, from being a currency, or money if you will. Logically the best part of its trading is conducted in above ground reserves. From my perspective the impact of global mine supply, which increases above ground stocks by roughly 1.5 % annually, and retail sales have less to do with gold’s price formation than is widely assumed.
Back to GFMS. Have a look at the picture below that shows their S&D flows for 2015.
GFMS pretends total supply is mine production plus some scrap, which is then met by jewelry demand in addition to retail investment, industrial fabrication and official sector purchases. The way they present it is misleading. These S&D flows are incomplete; they suggest gold is traded like any other commodity. But what about institutional S&D in above ground bullion? Trades that define gold as an international currency.
Let’s do another comparison; this time between what GFMS calls Identifiable Investment demand, consisting of…
Retail bar & coin
…versus my what I deem to be a more unadulterated approach of investment demand, consisting of…
Total [global] Identifiable Investment, … posted a modest 5 % increase in 2015, to reach 990 tonnes.
That’s quite a tonnage between global Identifiable Investment by GFMS at 990 tonnes and apparent Chinese institutional demand at 1,400 tonnes. We should also take into account non-apparent institutional demand, gold that changes hands in trading hubs like Switzerland. Unfortunately we can’t always measure institutional S&D, but that doesn’t justify denying its subsistence.
Have a look at the chart below that shows the large discrepancy. In the next chapter we’ll specifically discuss the significance of investment demand in relation to the price of gold.
My point being: what many gold market participants and observers think is total supply and demand is just the tip of the iceberg.This truly is a staggering misconception created by the firms.
When observing the GFMS balance in exhibit 1 its incompleteness is self-evident. At the bottom we can see the line item “net balance”, which reflects the difference between total supply and total demand. According to GFMS, if the “net balance” is a positive figure there was a surplus in the global gold market, and if “net balance” is a negative figure the market has been in deficit. In the real world this figure is irrelevant. Gold supply and demand are by definition always equal. One cannot sell gold without a buyer, and one cannot buy gold without a seller. Furthermore the gold market is deep and liquid. So how come there is a difference between total supply and total demand in the GFMS balance? As I’ve demonstrated before, because GFMS doesn’t include institutional S&D that in reality makes up for the difference and far beyond. In all its simplicity the “net balance” item reveals their data is incomplete.
Let’s have another stab at this. How can “net balance” exist in the real world, for example in 2009? According to GFMS the gold market had a 394 tonnes surplus in 2009. But how? Were miners left with 394 tonnes they couldn’t sell? Or some supranational entity decided to soak up the surplus to balance the market? Naturally, this is not what happens. Total supply and total demand are always equal, but GFMS doesn’t record all trades.
Moreover, in my opinion the words “surplus” and “deficit” do not apply to gold. There can be no deficit in gold; there will always be supply. At the right price that is. Sometimes Keynesian economists claim there is not enough gold in the world for it to serve as the global reserve currency. Austrian economists then respond by saying that there will always be enough gold at the right price. I agree with the Austrians and their argument also validates why there can be no deficit in gold.
There is more proof the “net balance” item presented by GFMS is meaningless. Although according to GFMS the market had a 394 tonnes “surplus” in 2009 the price went up by 25 % during that year. This makes no economic sense. A surplus suggests a declining price, not the other way around. Tellingly, S&D forces presented in GFMS balances are often negatively correlated to the gold price, as was the case in 2005, 2006, 2009, 2010 and 2014 (exhibit 1). In conclusion, GFMS S&D balances are not only incomplete, the resulting “net balance” items are misleading with respect to the price. Below are a few charts that demonstrate this conclusion.
If we plot “net balance” versus the end of year price of gold we can see the correlation is often negative. Have a look below. Green “net balance” chart bars show a positive correlation to the gold price, red chart bars show a negative correlation (note, the left axis is inverted for a more clear overview between any “deficit/surplus” and the price of gold). As you can see nearly half of the “net balance” chart bars are negatively correlated to the price of gold.
Mind you, although the “net balance” item is often negatively correlated to the gold price, in the Gold Survey 2016 GFMS states on page 9:
In terms of the Net Balance, 2015 marked the third year in which the gold market remained in surplus, and therefore it is not surprising that the bear market continued.
And on page 14:
The forecast reduction in global mine output and a gradual recovery in demand will see the physical surplus narrow in 2016, providing support to the gold price and laying the foundation for better prospects.
GFMS likes to pretend any “surplus” or “deficit” arising from their balance is correlated to the price, but the facts reveal this is not true.
Let us plot the “physical surplus/deficit” line item by GFMS (exhibit 1) versus the gold price. This results in even more negative correlations.
This exercise reveals that a positive correlation between either a “surplus” or “deficit” arising from a GFMS balance and the price of gold is just a coincidence. No surprise when one is aware their S&D data is incomplete.
Remarkably, the last chart was also published in the Gold Survey 2016, but GFMS chose not to invert the left axis and doesn’t disclose what we see is a surplus or deficit. As a result the largest surpluses (2006, 2007, 2009, 2010) seem to correlate with a rising price, though in reality they did the opposite. Compare the chart below with the one above.
GFMS also publishes S&D balances for silver (a monetary metal that is comparable to gold). For silver the presented correlations by GFMS between a “surplus” or “deficit” in relation to the price are even weaker.
According to GFMS the silver market is always in deficit, but the price goes up and down. Obviously GFMS neglects to measure institutional S&D for silver.
In my opinion, when Gold Fields Mineral Services (GFMS) was erected many decades ago they made a mistake to adopt a commodity S&D balance approach.Surely with the best intentions they gather intelligence and retrieve data from the market. But we must be aware this is not the full picture. The most significant data is not disclosed by GFMS.
When it comes to what drives the price of gold GFMS and I agree it’s determined by gold’s role as a currency in the global economy. When reading the chapter PRICE AND MARKET OUTLOOK in the Gold Survey 2016, GFMS shares its insights with respect to the gold price. Factors mentioned are:
Turmoil in global stock markets
A Chinese hard landing
Geopolitical tensions in the Middle-East
Central bank stimulus (QE)
Global economic weakness
Interest rates policy by central banks
Low risk asset / safe haven demand
So if these factors drive the gold price, in what S&D category would this materialize? Would (large) investors buy and sell jewelry? Or bullion bars? I think the latter. According to my analysis the price of gold is largely determined by institutional demand, and to a lesser extent ETF and retail bar & coin demand.
Let’s do an exercise to see what physical gold S&D trends correlate to the price. The majority of supply on the GFMS balance consists of mine output and the majority of demand on the GFMS balance consists of jewelry consumption. But if we plot these volumes versus the price of gold in a chart, there is no push and pull correlation*. For example, when the gold price surged from 2002 until 2011 jewelry consumption was not rising. Neither was it outpacing mine supply. The opposite happened, to be seen in the graph below. This is because jewelry demand is price sensitive – when the price goes up jewelry demand goes down, and vice versa. Jewelry demand is not driving the price of gold.
I also added retail bar & coin demand. Interesting to see is that retail bar & coin demand is on one hand a price driver, moving up and down in sync with the gold price, on the other hand it can be price sensitive having brief spikes when the price of gold declines.
The best correlation between physical S&D in relation to the gold price can be seen in institutional and ETF S&D. One of the largest gold trading hubs in the West is the UK, home of the London Bullion Market that also vaults the largest ETF named GLD. The UK has no domestic mine production, no refineries and national gold demand is neglectable in the greater scheme of things. Therefore, by measuring the net flow of the UK (import minus export) we can get a sense of Western institutional and ETF demand and supply. For example, if the UK is a net importer – import demand being greater than export supply – that signals a net pull on above ground stocks. Approximately one third of the UK’s net flow corresponds to ETF inventory changes, the other two thirds reflect pure institutional S&D.
In the charts above we can observe a remarkable solid correlation between the UK’s net flow and the gold price. The UK is a net importer on a rising price and net exporters on declining price. The shown correlation can’t be a coincidence, though there’s no guarantee it will prevail in the future.
The two charts above show the (medium/long term) gold price is mostly determined by institutional supply and demand in above ground reserves. Effectively, GFMS is hiding the most important part of global physical gold flows.
When I asked an analyst at one of the leading firms why his company doesn’t measure institutional S&D he told me candidly, “becauseit’s extremely difficult to accurately estimate it”. And it is. As I wrote previously, I can’t exactly measure global institutional S&D either. However, very often publicly available information gives us a valuable peek at it, and it shows to be more relevant to the gold price than what the firms keep staring at. Not knowing exactly what institutional S&D accounts for doesn’t mean GFMS shouldn’t pay attention to it.
But the firms keep trying to uphold the illusion the data they’ve been selling for decades is complete. For if they would plainly confess it was incomplete, future business could be severely damaged.
What I blame these firms is that they’ve created a meme that the gold market is as large as annual mine supply. This has caused all sorts of misconceptions. Often I read analyses based on a comparison between quantitative demand and mine output. Such analyses are likely to jump erroneous conclusions.
An often-perceived analysis in the gold community is that gold is the constant in our global economy. But is this true? Yes and no. Allow me to share my observations. Although gold has an exceptionally constant nature, and we have yet to see another currency that can compete with gold’s constant nature, the reality is, that there is no exact constant in economics. In any market all goods, assets, currencies, etc. continuously fluctuate in value relative to each other due to ever changing supply and demand dynamics. Having said that, in this post we’ll examine gold’s constant nature by measuring its purchasing power in the short (weeks) medium (years) and long term (decades). Additionally, we’ll compare our findings to fiat’s nature.
We will find that when gold is officially recognized as the center of a monetary system – throughout history there have been several forms of gold standards – gold is approximately constant in the short, medium and long term. Since the gold standard has been abandoned, the metal has become less constant in the short and medium term, but has remained impressively constant in the long term.
In turn, fiat can have periods of being constant in the short term, but will always lose value in the medium term and evaporate in the long term. Thereby, due to fiat’s fragile nature and the current stress in global finance, there are also risks fiat can significantly devalue overnight. Hence, gold is highly suitable to secure one’s purchasing power.
When examining the value of gold we have to measure it in terms of goods and services. In this day and age one might forget the end goal of any participant in the economy is goods and services. All else traded in our vast financial system is merely a means to an end. All sorts of money, but also stocks, bonds, credit default swaps, options, futures, etc., have no use-value for humans as we can’t eat, drink or wear them. Only goods and services we can truly use (for more information regarding use-value please read my post The Concept Of Money.) Therefor, to measure the stability of gold’s value we have to compute the amount of goods and services gold can buy.
For the sake of simplicity, we’ll use publicly available Consumer Price Index (CPI) and Wholesale Price Index (WPI) data to measure the value of goods and services.
Gold’s Purchasing Power In The Short And Medium Term
On occasion we can read gold commentators stating that when the price of gold rises or falls in the short term, it’s actually fiat that is falling or rising. As, according to this analysis gold is the constant. Let’s test if this analysis is accurate. In the week from January 4 until January 9, 2016, the price of gold in British pounds surged 5.9 % from £23,096 pound per Kg to £24,469 per Kg. We can be quite sure that the price of goods and services in the UK remained flat during this period. As a consequence, in this example gold could buy 5.9 % more goods and services at the end of the week, whilst sterling could buy exactly the same amount of goods and services all week long. So, in this particular example, what was more constant? It was sterling. The reason is that currently the international monetary standard is fiat.
Moving on to the medium term. In the chart below I’ve plotted the purchasing power index of gold versus the British pound, based on CPI data and the gold price, from July 2010 until June 2016.
Over this period we can observe that the British pound was more constant than gold in the short term, but it’s purchasing power has been declining in the medium term due to the inherent inflationary policies by the central bank of the UK. Gold’s purchasing power has been volatile in the short and medium term, but in this case has remained its purchasing power over the shown period. Though, it should be clear that if I would’ve adjusted the period gold’s purchasing power could’ve shown an increase or decrease.
Gold’s Purchasing Power in the Long Term
To get the best understanding of his subject, let us zoom out and have a look at gold and the pound’s purchasing power since 1500. The following chart is conceived by Nick Laird from GCRU, based on data collected by himself and Roy Jastram. The chart is perhaps more difficult to interpret than the previous one. To be clear, we can see 3 index lines:
The red line reflects gold’s purchasing power index (1930 = 100)
The blue line reflects the price of gold index, denominated in British pounds (1930 =100). Note, until 1914 the blue line was mostly straight which shows fixed parities between sterling and gold.
The green line reflects the wholesale (/goods) price index, denominated in British pounds (1930 = 100)
As you can see, if the price of gold (blue) transcends wholesale prices (green), as a consequence gold’s purchasing power (red) is escalated – and vice versa.
Clearly the red line has remained roughly flat, around 100, for hundreds of years! This shows gold’s remarkable constant nature. Note, since the gold standard has been gradually dismantled (1914) gold’s purchasing power became more volatile but remained robust in the long term.
Furthermore, we can see that prior to 1914 wholesale prices were also fairly constant but this is due to the fact sterling was tied to gold during this era. Since the gold standard was abandoned step-by-step from 1914 onwards, the blue and the green line have skyrocketed, evaporating the purchasing power of sterling. Since 1971 the British pound has lost over 93 % of its purchasing power – in 1975 inflation topped 20 %.
We can conclude, while there is no exact constant in economics, the stability of gold’s purchasing power is unprecedented. Not only on a gold standard the metal shows it’s constant nature, but also off the gold standard gold’s purchasing power is remarkably constant, albeit more volatile in the short term.
For the future, if the current fiat international monetary system will breach its limits and has to be re-anchored to gold, I expect gold to become more constant in both the short and medium term when providing a center pillar in finance.
In 2013 we’ve witnessed the inception of the Chinese gold ETF market. At first demand for the gold ETFs was neglectable, as investors mostly preferred to buy the physical gold directly at the Shanghai Gold Exchange (SGE) or buy jewelry or investment bars through retail channels. This year, however, there has been a major shift in gold ETF demand in China.
The physical holdings of Chinese gold ETFs have surged five-fold from 7 tonnes at the end of January, to 35 tonnes at end of August. The Huaán Yifu Gold ETF, which was holding 23 tonnes in August, entered the global top 15 list.
The interest in China’s nascent gold ETF market was even mentioned by the World Gold Council in a recent Gold Demand Trends report. In this post, we’ll add some texture to China’s gold ETF market; how are the gold ETFs constructed and how can they be compared to the largest Western gold ETF, the SPDR Gold Trust. At this moment the market share of Chinese gold ETFs is still small – within China as well as globally, but knowledge about the workings of these ETFs will be valuable when they acquire significant market share in the future.
Kindly note, all mechanics and examples presented in this post are simplified.
What Is A Gold ETF?
ETF is short for Exchange Traded Fund. ETFs trade like stocks and its price usually tracks an underlying asset or index. Like stocks, ETFs have a primary market and a secondary market. The secondary market is the stock exchange where most ETF investors trade. What makes ETFs special is the primary market where ETF shares are created and redeemed. Let us use the SPDR Gold Trust (symbol: GLD) to illustrate how the primary market works. Mainly through the creation and redemption process of shares, the GLD share price tracks the gold price.
The Authorised Participants (the institutions which are authorised to create and redeem GLD shares, at this moment the Authorised Participants are Barclays Capital, Inc., Credit Suisse Securities (USA) LLC, Goldman Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., P. Morgan Securities Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, Scotia Capital (USA) Inc., UBS Securities LLC and Virtu Financial BD LLC).
If an Authorised Participant (AP) wants to create GLD shares, it needs to deposit gold into the account of the Trust and subsequently the Trustee will provide the AP with GLD shares. The creation application must be made in multiples of 100,000 shares (a block of 100,000 shares is called a basket). Since every GLD share represents approximately 0.1 ounce of gold, in order to create 100,000 GLD shares the AP needs to deposit 10,000 ounces of gold into the account of the Trust. (In reality, 1 GLD share actually represents a little less than 0.1 ounce of gold, the reason for this will be explained later on in this post.)
The redemption process works the other way round. If an AP wants to redeem GLD shares, it deposits 100,000 GLD shares at the Trust and subsequently the AP receives 10,000 ounces of gold.
The purpose of APs creating and redeeming GLD shares is usually arbitrage. As previously mentioned the gold equivalent of 1 GLD share is roughly 0.1 ounce, nevertheless GLD shares and actual gold are traded in two different markets. As a consequence, the price of 1 GLD share can differ from the price of 0.1 ounce of gold. If the price of GLD and the price of gold diverge, this is where arbitrage comes into play for the APs. Accordingly, the arbitrage by APs through creation and redemption of shares contributes to GLD’s price tracking the gold price.
Suppose (simplified), the price of 1 GLD share is $110 – caused by supply and demand for GLD shares at the NYSE Arca – while the price of 0.1 ounce of gold is $100 in the gold market. An AP can grasp this opportunity by buying (or first leasing) 10,000 ounces of gold to deposit in the GLD Trust account after which the Trustee will create 100,000 GLD shares for the AP. The new shares created are then sold by the AP on the stock market, which will cause the price of GLD to go down. The arbitrage opportunity will be used by APs until it’s closed.
If the price of GLD shares is lower than the price of gold, the arbitrage opportunity works the other way around, APs can buy shares, redeem them for gold at the Trustee and sell the gold.
In the aforementioned example trade when the AP (via the Trustee) created 100,000 GLD shares his investment was $10,000,000 (10,000 ounces at $100 per 0.1 ounce). The AP’s revenue was $11,000,000 (100,000 GLD shares worth $110 a piece). The AP’s profit in this exercise was $1,000,000.
($110-$100)*100,000 = $1,000,000
As readers can see from the example, the holdings of GLD were increased by 10,000 ounces of gold. Almost every day the holdings of GLD vary and the change is often caused by arbitrage of APs.
One theory is, when demand for GLD shares is strong (usually by Western investors) and the share price is trending higher than the price of the gold equivalent, the APs jump the arbitrage, create shares and GLD inventory swells. Then, if growth in GLD inventory correlates to a surging gold price (which can be observed in exhibit 3 below) we can speculate the gold bull market in part has been caused by Western investment demand in GLD.
Now we have established the workings of the largest Western gold ETF, we will have a look at how the Chinese gold ETFs are constructed, and compare them to GLD.
China’s Gold ETF Market
Below are the 4 Chinese gold ETFs currently in existence that we’ll discuss.
- Bosera Gold Exchange Open-Ended Securities Investment Fund
- Guotai Gold Exchange Open-Ended Securities Investment Fund
- Huaán Yifu Gold Exchange Open-Ended Securities Investment Fund
- Efund Gold Exchange Open-Ended Securities Investment Fund
In China every gold ETF share represents approximately 0.01 gram of gold. By creating or redeeming gold ETF shares (Chinese) APs receive or deliver a basket of 300,000 shares, which equals to 3Kg of gold. This threshold is much lower than that of GLD, of which a basket equals to 310Kg of gold. The gold acceptable for Chinese ETFs are the spot (physical and spot deferred) gold contracts listed on theSGE – for example Au99.99. Therefore, all the physical holdings of China’s gold ETFs are stored within SGE designated vaults.
Moreover, there is a range of features that make China’s gold ETFs quite different from GLD.
1. Chinese Gold ETF Shares Can Also Be Created Or Redeemed Through Cash
Unlike GLD, which only allows the use of gold to create shares, and only allows the use of shares to redeem gold, China’s gold ETFs also allow shares to be created and redeemed through cash in the primary market. An AP can present cash to the Fund Manager who handles the creation and redemption process for a Chinese gold ETF. The Fund Manager is comparable to the Trustee of GLD. Thereby, through an AP individual investors can create or redeem gold ETF shares with cash as well.
Suppose, a Chinese investor wants to arbitrage the difference between the price of a gold ETF and the price of gold. In this example the price of the gold ETF is higher than the price of gold, so the investor want use cash to create shares to sell on the stock market. The investor can present cash to an AP who in turn will create shares via the Fund Manager. The amount of cash used in this transaction to create shares is equal to the cash value of the spot gold contracts that are needed to create the shares without the use of cash.
Vice versa, in case an investor wants to arbitrage the price of a gold ETF when it’s lower than the price of gold, the investor can present shares to an AP to redeem for cash.
In China the APs can be securities firms and commercial banks. The securities firms are often not SGE members. Therefor, the number of APs that support gold ETF shares creation and redemption through cash is often larger than the number of those that support shares creation and redemption through spot gold contracts. For example, in the case of Efund Gold ETF, the fund has authorised 13 securities firms (APs) to process creation and redemption through cash, but only 2 banks (APs) to process creation and redemption through spot gold contracts (Industrial and Commercial Bank of China and Bank of Communications).
2. The Flexibility Of The Fund Manager
The Trustee of GLD doesn’t have much flexibility in managing the assets. Its duty is mainly processing the creation and redemption orders of GLD shares. Therefore, the gold holdings of GLD are mainly allocated gold and according to the prospectus [brackets added by me]:
Gold held in the Trust [GLD]’s allocated account is the property of the Trust and is not traded, leased or loaned under any circumstances.
In China, the Fund Managers of the gold ETFs have more flexibility. The gold contracts that China’s gold ETFs hold include not only spot physical contracts like Au99.99 and Au99.95, but can also be spot deferred contracts like Au (T+D), and notable all these “spot contracts” may be leased (sometimes swapped) within the SGE system. Additionally, every Chinese gold ETF can invest 10% of its fund assets (5 % of net fund assets in case of Efund Gold ETF) in “other financial instruments” allowed by the China Securities Regulatory Commission (CSRC).
For example, the excerpt below is from the Efund Gold ETF’s prospectus [brackets added by me]:
The investment scope of the Fund [Efund Gold ETF] is liquid financial instruments, including gold physical contracts (including spot physical contracts, spot deferred contracts, etc), bonds, asset-backed securities, bond repos, bank deposits, money market instruments, and other financial instruments which laws, regulations or the CSRC allow the Fund to invest in the future (but these have to satisfy the relevant rules of the CSRC).
If laws, regulations or regulatory institutions allow the Fund to invest in other instruments (including but not restricted to gold derivatives like forwards, futures, options and swaps), after necessary procedures, the Fund Manager will include them into the investment scope.
The portfolio percentage: The fund asset invested in gold spot contracts is not lower than 95% of the net asset value of the Fund.
All the 4 gold ETFs in China can participate in gold leasing. Some can participate in gold swaps and some can pledge the gold to borrow money.
The excerpt below is from the Huaán Yifu Gold ETF Prospectus:
The Fund can do gold lease and pledge gold to borrow money.
Effectively the Fund Manager of the Huaán Yifu Gold ETF can make money by, for example, leasing the fund’s assets.
The excerpt below is From the Guotai Gold ETF Prospectus:
The Fund can do gold lease, gold swap and invest in gold spot deferred contracts, etc, in order to lower the operating expenses and lower tracking error. The Fund does margin trade only for the purpose of risk management and enhancement of the efficiency of the asset allocation.
As a result, the Fund Managers of Chinese gold ETFs have significant flexibility in handling the fund assets. Please remember that all gold leasing, swapping, etc. has to be done within the SGE system and the gold cannot leave the SGE designated vaults.
Article 4. Gold ETFs may not deposit physical gold into the [SGE] vault or withdraw physical gold from the [SGE] vault. Margin trade is only for the purpose of risk management and enhancement of the efficiency of the asset allocation.
3. NAV Per Share Recalculation
Since the inception of GLD in 2004 its share gold equivalent is steadily declining lower than 0.1 ounce of gold. That’s because the Sponsor, Trustee and Custodian don’t provide services for free. They need to earn money and their earnings must come from the Net Asset Value (NAV) of the ETF. In other words, the gold in the Trust is gradually sold to pay for operational expenses. From the GLD prospectus:
The amount of gold represented by the Shares will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.
Each outstanding Share represents a fractional, undivided interest in the gold held by the Trust. The Trust does not generate any income and regularly sells gold to pay for its ongoing expenses. Therefore, the amount of gold represented by each Share has gradually declined over time. This is also true with respect to Shares that are issued in exchange for additional deposits of gold into the Trust, as the amount of gold required to create Shares proportionately reflects the amount of gold represented by the Shares outstanding at the time of creation. Assuming a constant gold price, the trading price of the Shares is expected to gradually decline relative to the price of gold as the amount of gold represented by the Shares gradually declines.
On November 18, 2004, 1 GLD share exactly equaled 0.1 ounces of gold, but by now (September 2016) 1 GLD share equals 0.09542 ounces of gold, a decline of almost 5 % over the course of 12 years. This explains why currently the amount of ounces needed by an AP to create a basket of shares has become less than 10,000 ounces, and continues to decline.
In China’s gold ETF market, although the gold represented by the ETF instruments also decline as with GLD, the share values are periodically re-adjusted to ensure the NAV per share remains (roughly) 0.01 gram of gold.
For example, from the Bosera Gold ETF prospectus:
Fund share re-calculation means the fund manager based on the necessity of the operation of the fund, under the premise that the total NAV is unchanged, adjusts the total fund shares outstanding and NAV per share.
There is nothing complicated about the re-calculation. There are simply periodic adjustments when the Fund Manager sets the value of the shares (in yuan) higher because the gold content equivalent is elevated, from below 0.01 gram to 0.01 gram, whereby the Fund Manger “adjusts the total fund shares outstanding” downward.
4. Linked Funds
In China, every gold ETF is accompanied by a Linked Fund. The Linked Fund mainly invests in the Target Gold ETF as can be seen in the list below. The Linked Fund is usually a common open-ended mutual fund. While 90 % of the assets under management of the Linked Fund must be invested in its Target Gold ETF, the Fund Manager still has some room for managing the remaining 10%.
For example, from the Bosera Gold ETF-linked Fund’s prospectus:
The Fund mainly invests in Bosera Gold Exchange Open-Ended Securities Investment Fund, gold contracts listed on the Shanghai Gold Exchange, gold futures contracts listed on the Shanghai Futures Exchange, bonds and other financial instruments which the CSRC allows the fund to invest, like securities lending and borrowing, gold lease, etc.
For more clarity I’ve drawn a graph to illustrate the ratios of investment allocation by the Guotai Gold ETF and the Guotai Gold ETF-linked Fund.
Although, at this stage it’s not completely clear to me what would be the benefit for investors to invest in the Linked Fund, as opposed to the Target Gold ETF.
5. Voting Rights
GLD holders only have limited voting rights. The excerpt below is from the GLD prospectus,
Under the Trust Indenture, Shareholders have no voting rights, except in the following limited circumstances: (i) shareholders holding at least 66.66% of the Shares outstanding may vote to remove the Trustee; (ii) the Trustee may terminate the Trust upon the agreement of Shareholders owning at least 66.66% of the outstanding Shares; and (iii) certain amendments to the Trust Indenture require 51% or unanimous consent of the Shareholders.
In China’s gold ETFs shareholders have more voting rights and can vote to decide on a lot of important issues. The excerpt below is from the prospectus of Bosera Gold ETF:
In one of the following circumstances, based on the consent of the fund manager, the fund custodian or the fund shareholders who hold 10% (including 10%) of the fund shares outstanding, it is mandatory to hold fund shareholders’ meeting:
1. Termination of the fund contract;
2. Change of the operation of the fund;
3. Increase of the remuneration of the fund manager or the fund custodian, but excluding the circumstances in which the increase of the remuneration is mandatory by the requirements of laws or regulations;
4. Replacement of the fund manager or fund custodian;
5. Amendment of the fund category;
6. Amendment of the fund investment target, scope or strategy (excluding the circumstances in which laws, regulations or the CSRC have other relevant requirements);
7. Amendment of fund share holders’ meeting proceedings, voting methods and voting procedures;
8. Termination of listing but excluding circumstances in which the fund no longer satisfies listing requirements and the listing is terminated by the Shenzhen Stock Exchange;
9. Merger of the fund with other fund(s);
10. Other items that have material influence on the rights and responsibilities of the parties to the fund contract and necessitate the fund share holders’ meeting to amend the fund contract;
11. Other items that are required by laws, regulations, the fund contract or the requirements of the CSRC to hold the fund share holders’ meeting.
Even the Linked Fund shareholders of China’s Gold ETFs can participate in voting:
The fund shareholders of the linked fund of this fund can attend or send representatives to attend the fund shareholders’ meeting and participate in voting, based on the share holding of the linked fund. The equivalent number of fund shares with voting rights and correspondent votes are: the product of the total shares of this fund held by the linked fund multiplied by the linked fund shares held by the respective link fund share holder as a percentage of the total linked fund shares outstanding. The result of the calculation is rounded to the nearest whole number.
Ironically, to me there seems to be more democracy and openness in China’s gold ETFs than in GLD. On the other hand, Chinese gold ETFs have a fundamentally different foundation, a hybrid design I would say.
China’s gold ETF market was erected in 2013 and is still evolving. In the future, there may be more complex gold ETF related financial structures that have a big impact on China’s overall gold market. I shall follow it closely.
My hunt for the gold bar list of the Dutch official gold reserves started in 2015. On September 26 of that year I visited a conference in Rotterdam, the Netherlands, called Reinvent Money. One of the speakers was Jacob De Haan from the Dutch central bank (DNB) Economics and Research Division – you can watch his presentation by clicking here.
In his presentation De Haan repeatedly talked about the importance of transparency in central banking. These statements raised my eyebrows, as I submitted a FOIA request at DNB in 2013 to ask for all correspondence between DNB and other central banks in the past 45 years with respect to its monetary gold, which was not honored. From my experience DNB was anything but transparent.
After the presentation I approached De Haan and asked him, if transparency is so important to DNB, why has it never published its gold bar list? An act of transparency that could be accomplished within minutes. De Haan offered me he would look into that. He gave me his email address and we agreed to stay in touch.
The next day I send De Haan an extensive email explicating my request at DNB to publish the gold bar list of the Dutch gold in excel sheet format. I wrote him it wouldn’t take DNB any effort, as I assumed the bar list was readily available.
De Haan never replied to my email, so I called his office in December 2015 to ask what the status was of my request. De Haan’s secretary answered my inquiry was not rejected but still being processed.
Weeks passed but I didn’t get any reply from De Haan.
On February 24, 2016, I decided to call DNB’s press department to ask about my inquiry. DNB’s spokesman, Martijn Pols, told me over the phone the subject was still being discussed internally, he even confirmed De Haan was involved in the decision making. DNB was considering releasing the document while carefully weighing al pros and cons, he said.
In the conversation Pols stated DNB was aware the German central bank (the Deutsche Bundesbank) released a bar list in October 2015 and there was a wish in Amsterdam to mutually harmonize this policy. I added that if DNB would go ahead with the publication their action would only be credible if the Dutch bar list would be complete (disclosing refinery brands, refinery bar numbers and year of manufacturing), in contrast to the incomplete list the Germans had published. Pols was aware of the format the Germans had chosen and took note of my comment. An ensuing question from my side what was holding back DNB in releasing the list could not be clearly answered.
Months passed without any news from DNB. On August 8, 2016 I decided to call Pols again for a status update. He said he would reply over email. A few days later I received an email from DNB Head of Commutations J.W. Stal.
…. We can share the following information with respect to our gold reserves.
DNB is transparent about the amount (weight) and the value of our gold assets. This information can be found in our annual reports. Thereby, several media have visited the gold vault and video recordings have also been made. However, we do not intend to publish a gold bar list. This serves no additional monetary purpose to our aforementioned transparency policy, however it would incur administrative costs.
If you have any further question please contacts us.
Of course, in this day and age any gold bar list from a central banks should be readily available in excel sheet format, and releasing a sheet would not incur any administrative costs.
If the sole reason not to publish the gold bar list is that such an action would incur administrative costs I must conclude DNB doesn’t have the list readily available. Or is my conclusion erroneous? Does DNB have a complete gold bar list readily available or not?
If not, this is worrying because the gold bar list forms one of the most important checks on the existence of the Dutch official gold reserves, which provide essential stability to our economy.
In response to your email of August 11, 2016, to De Nederlandsche Bank (DNB), we can inform you as follows on our gold reserves and the related gold bar list. DNB has internal gold bar lists, however the conversion of internal lists to documents for publication would create too many administrative burdens.
We maintain our previous email, in which we stated publishing a gold bar list serves no monetary purpose other than transparency. And as previously noted, there are other ways for DNB to transparently communicate about our gold stocks.
We trust to have informed you sufficiently.
If DNB has its gold bar list properly (digitally) archived there should be no administrative cost whatsoever for publication. The argument presented by Stal makes absolutely no sense to me. If one owns over 600 tonnes of gold, why not have the physical assets accurately inventoried?
What could possibly be the problem to release the bar list of the Dutch gold located in Amsterdam, New York, Ottawa and London?
I would like to remind you that DNB is the only Western central bank that in recent years has successfully repatriated a significant amount of gold (122.5 tonnes) from the Federal Reserve Bank Of New York through a covertly executed operation. This underlines DNB is fully aware of the importance of its gold reserves in our current fragile financial climate. I think DNB does have the bar list readily available, but it chooses not to publish it for political reasons – think, tensions between its custodians in New York and London.
DNB claims to be transparent but in reality it’s not.
Since 2014 I’ve been investigating the alleged audits of the US official gold reserves. Of course my goal is to figure out if these audits are credible, or if they’re invented by the US government to silence the people that think gold has any value and forms the very material basis for a well-functioning monetary system.
My first post on this subject, A First Glance At US Official Gold Reserves Audits, published on March 27, 2014, was purely based on publicly available reports. Not surprisingly, all those reports together compounded to a logical story. The US government wouldn’t present anything that’s implausible at the surface. That first post was more or less a summary of the official narrative. After that post I decided to dig a little deeper.
According to the Department of the Treasury’s Office of Inspector General (OIG), which is responsible for the audits, the vast majority of the US monetary stock stored at the US Mint had been audited by 1986, 241,247,820.61 fine troy ounces to be precise, as was said by Inspector General Eric M. Thorson during his Statement to the House Financial Services Committee on June 23, 2011:
… the Committee for Continuing Audit of the U.S. Government-owned Gold performed annual audits of Treasury’s gold reserves from 1975 to 1986. … by 1986, 97 percent of the Government-owned gold held by the Mint had been audited and placed under joint seal.
If this is true I would like to see those audit reports, I thought one day. My first Freedom Of Information Act (FOIA) request submitted in 2015 at the US government asked for delivery of all audit reports drafted by the Committee for Continuing Audit of the U.S. Government-owned Gold from 1975 until 1986. Stunningly, the OIG couldn’t find all the documents – nor did the National Archives, the Government Accountability Office or the Treasury. The OIG only had three of the audit reports in question archived. Something was awfully wrong here.
The essence of auditing the US gold stock is to reassure the global economy that in any extreme scenario all dollars in circulation are supported by gold providing essential confidence and credibility. Once it’s proven the gold is there, why throw away the evidence? I wrote about this in my post US Government Lost 7 Fort Knox Gold Audit Reports published on June 2, 2015.
In my post from June 2015 I announced I would submit new FOIAs at several US government departments to get to the bottom of this. And I did, I’ve submitted countless of FOIAs at the US Treasury, US Mint and the OIG, next to asking for information through conventional channels like email and phone calls. Sometimes the FOIAs were not honored, sometimes I received very intriguing bits of information. What I found out, inter alia, was that in between 1993 and 2008, 84,671,927 ounces were re-audited. Meaning, several compartments that were sealed in between 1975 and 1986 had been re-opened to access the bars inside. And strangely, the OIG cannot give me a proper explanation for these re-audits. Believe me, I’ve tried to ask numerous times.
Why was this gold re-audited? Why were sealed vault compartments re-opened and re-audited? These are just examples of questions my research is focussed on.
My interest in the subject did not pass unnoticed at the US government. In recent months I could clearly sense a strong defense by all departments in concert. Emails are not being answered, phone calls are not being returned, questions in my FOIAs are dodged, and in my most recent FOIA an unreasonable amount of money was asked for reports the Mint Director’s Representative writes every year for “notifying the CFO of the completion of the verification” of the Deep Storage gold audits.
5. Policy FIN-09, Deep Storage Asset verifications, paragraph 2v, and MD 8H-3 paragraph 6a, both include the requirement that the Director’s Representative submit a written report to the Chief Financial Officer (CFO) notifying the CFO of the completion of the verification.
After reading this paragraph I thought maybe these reports by the Mint Director’s Representative would disclose valuable information. As the US government was barely talking to me anymore, I submitted a new FOIA request at the Mint in 2016 that stated:
In the “Management Letter for the Fiscal Year 2004 Audit of the United States Mint’s Schedule of Custodial Gold and Silver Reserves March 10, 2005”, drafted by the OIG, it states:
“Policy FIN-09, Deep Storage Asset Verifications, paragraph 2v, and MD 8H-3 paragraph 6a, both include the requirement that the Director’s Representative submit a written report to the Chief Financial Officer (CFO) notifying the CFO of the completion of the verification.”
I would like to obtain all these reports by the US Mint Director’s Representative to the Chief Financial Officer written 1993 – 2008.
The Mint replied this request would costs $3,144.96 dollars, because it would take forty hours to search the documents – as the requested documents are located at another facility – eight hours to review the documents and additional costs would be added to duplicate 1,200 pages of documentation. I think this is nonsense; it shouldn’t take forty hours to search these documents and I would be surprised if they actually count 1,200 pages. This is just another way of trying to shake me off.
However, thanks to Henry Young‘s advice on Twitter I decided to launch a crowdfunding campaign on GoFundMe to collect the money! If we all donate a few bucks, who knows what comes out!
I’ve started a crowdfunding campaign to collect the money for the FOIA re Fort Knox!! Please click here and retweet https://t.co/XsNs607zwS
After I tweeted about the campaign it quickly went viral. The news was spread on websites such as TFMetals, GoldMoney, GATA and GoldChartsRus – among others – and within a few hours the funding was completed, which shows to me the power of our gold community! I was truly overwhelmed by everybody’s generous donations and support. As of this moment there is even more money collected than I asked for at GoFundMe (please stop donating!). The residual will be saved for when the costs appear to be higher or if they charge me for any other FOIA I’ve submitted. Naturally, I will publicly keep a record of expenditures in the comment section of my GoFundMe page.
Next for me is to transfer the money to the US Treasury and wait what they’ll sent back. If I’m offline for a weeks in September, that’s because I’m digesting 1,200 pages of dense jargon.
I will disclose a list with all the names (mostly Turdites) who have donated in the finished post on the audits of the US official gold reserves. For now, thanks everybody who donated and I’ll keep you posted!!
Debunking the Thomson Reuters GFMS Gold Survey 2016 report. New information provides a more detailed perspective on the Chinese domestic gold market.
In the Gold Survey 2016 report by GFMS that covers the global gold market for calendar year 2015 Chinese gold consumption was assessed at 867 tonnes. As Chinese wholesale demand, measured by withdrawals from Shanghai Gold Exchange designated vaults, accounted for 2,596 tonnes in 2015 the difference reached an extraordinary peak for the year. In an attempt to explain the 1,729 tonne gap GFMS presents three brand new (misleading) arguments in the Gold Survey 2016 and reused one old argument, while it abandoned five arguments previously put forward in Gold Survey reports and by GFMS employees at forums. Very few of all these arguments have ever proven to be valid, illustrated by the fact that GFMS perpetually keeps making up new ones, and thus gold investors around the world continue to be fooled about Chinese gold demand. For some reason GFMS is restrained in disclosing that any individual or institution in China can directly buy and withdraw gold at the Shanghai Gold Exchange, which is the most significant reason for the discrepancy in question.
According to my estimates true Chinese gold demand in 2015 must have been north of 2,250 tonnes.
The reason I keep writing about this subject (the discrepancy in question) is that it eventually will enable me to show that global physical gold supply and demand as presented by GFMS is just the tip of the iceberg. And, as stated in my previous post true physical supply and demand is far more relevant to the gold price than the numbers by GFMS.
New Information has enabled me to shine a fresh light on the Chinese domestic gold market, so we’ll zoom in once again to get the best assessment of the mechanics of this market. This post is part two of an overview of the Chinese gold market for 2015. In the first part we focused on the (paper) volumes traded on the Shanghai Gold Exchange (SGE) and Shanghai International Gold Exchange (SGEI). In this post we’ll focus on the size and mechanics of the Chinese physical gold market, while at the same time addressing the fallacious information in the Gold Survey 2016 (GS2016).
The Gold Surplus In China According to GFMS
First, let’s have a look at an overview of the key supply and demand data points for 2013, 2014 and 2015, as disclosed in Gold Survey reports by GFMS.
Without GFMS mentioning the volume of SGE withdrawals for 2015 (2,596 tonnes) in the GS2016 they disclose apparent supply in the Chinese domestic gold market at 2,293 tonnes. Mine output accounted for 458 tonnes (page 22), scrap supply for 225 tonnes (page 36) and net import was 1,610 tonnes (page 54). The latter is incorrect because GFMS has double counted 63 tonnes Australia exported to China, as demonstrated in my post Australia Customs Department Confirms BullionStar’s Analysis On Gold Export To China, but the let’s not nitpick.
On other pages in the GS2016 we read total (consumer) demand for 2015 was 867 tonnes (page 52), consisting of retail bar demand at 199 tonnes (page 52) and gold fabrication at 668 tonnes (page 41).According to their own data there was a surplus of 1,426 tonnes (2,293 – 867) in the Chinese gold market. Whilst, in 2013 the surplus accounted for 826 tonnes and in 2014 for 917 tonnes, according to data disclosed in previous Gold Survey reports. Meaning, in the past three years GFMS has observed 3,169 tonnes (826 + 917 + 1,426) that were supplied to China not to meet demand, but for reasons that are constantly changing- wait till we get to the plea.
Remarkably, in the GS2016 report GFMS writes:
Hong Kong remained the primary conduit of Chinese gold imports, though its share has been contracting since 2013 … Gold import from this conduit was traditionally regarded as a simple proxy to estimate Chinese consumption … The declining dominance of Hong Kong and the increasing proportion directly routed into Beijing and Shanghai therefore points to the necessity of changes on methodology to calculate Chinese gold demand.
GFMS states that when all Chinese imports came in through Hong Kong this inflow was “regarded as a simple proxy to estimate Chinese consumption”, but now gold is also being imported directly from countries like Australia, the UK and Switzerland, such inflow “points to the necessity of changes on methodology to calculate Chinese gold demand”. How can it be that a couple of years ago Chinese gold import from Hong Kong reflected demand, but a few years later direct massive additional import from the UK and Australia does not reflect demand?
As you probably know (otherwise you can read it here) most of the gold supply in China flows through the SGE. Consequently wholesale demand can be measured by the amount of gold withdrawn from SGE designated vaults. Comparable to the difference between apparent supply and consumer demand shown in exhibit 1, is the difference between SGE withdrawals and consumer demand – the latter being even wider.
In the GS2016 GFMS has written a chapter fully dedicated to the humongous difference between SGE withdrawals and their assessment of demand. The chapter is titled “A Review And Explanation Of How China’s SGE’s Withdraw Numbers Are Impacted By Other Trading Activities”. In this post we’ll only briefly discuss whether the arguments are valid, as one of them has to do with China’s highly complex VAT system and I like to expand on this subject in detail in a separated post. However, we’ll expose more of the mechanics of the Chinese domestic gold market in this post, which conveniently demonstrates why nearly all the arguments by GFMS that will be discussed later on are bogus.
This might surprise you, but I actually had fruitful correspondence in the past months with a Senior Precious Metals Analyst at GFMS and a Senior Analyst at Metals Focus (MF). Both gentlemen have been very helpful in sharing their methodology for computing (Chinese) physical supply and demand data.I have to say both of them have answered all my questions. This service is seldom provided by the the World Gold Council, the Bank Of England or the London Bullion Market Association. Based on the information shared by GFMS and MF I’ve refined my view on our on-going disagreement with respect to the Chinese gold demand.
The Mechanics Of The Chinese Domestic Gold Market And Estimating True Chinese gold demand.
Let us refresh our memory regarding the structure of this market. In the Chinese domestic gold market nearly all physical gold supply and demand flows through the SGE because all bullion import1 into the domestic market is required to be sold first through the SGE and there are rules and tax incentives that funnel nearly all domestic mine output and scrap supply through the central bourse. As gold in the Chinese domestic market is not allowed to be exported1,the amount of gold withdrawn from SGE designated vaults therefore serves as a decent indicator for wholesale demand.
However, there are a few possibilities through which SGE withdrawals can be distorted for measuring demand.
If metal is in some manner recycled2 through the central bourse. When gold is bought and withdrawn from the SGE vaults and promptly sold and deposited into SGE vaults (for example though process scrap), these flows would inflate SGE withdrawals while not having a net effect on the price of gold, hence the related supply and demand volumes would be deceiving. Although article 23 from the Detailed Rules for Physical Delivery Of the Shanghai Gold Exchange states that bars withdrawn from SGE designated vaults are not allowed to re-enter these vaults, this rule does not fully prevent gold from being recycled through the exchange. If bars withdrawn are re-melted and assayed by an SGE approved refinery they are allowed back into the vaults. And thus, some recycled gold can inflate SGE withdrawals as a measure for true demand.
For ease of reference we’ll label the amount of gold recycled through the SGE that has no net effect on the price, and gold withdrawn from SGEI vaults that is not imported into the Chinese domestic market as distortion2.
Therefor, in order for us to make the best estimate of true Chinese gold demand we should subtract the amount of distortion from SGE withdrawals. The crux of true Chinese gold demand is establishing the amount of distortion, that’s it.
Previously I assumed the scrap numbers by GFMS mainly reflected gold that was making it’s way back to the SGE and these flows included disinvestment. Both assumptions appeared to be false.
Scrap numbers from GFMS and MF, although they’re certainly not equal, are collected from refiners that are not all SGE members. Implying not all refineries scrap is making its way to the SGE, but is sold through other channels.
Scrap numbers from GFMS and MF include jewelry and industrial products sold back from consumers, they do not include disinvestment that flows directly through refineries to the SGE. GFMS does measure disinvestment at retail level, for example, when people sell bars back to banks these will get netted out to compute net retail bar demand. But if an affluent investor or institution wants to sell (disinvest) 500 Kg they’re likely to approach a refinery directly.
In my nomenclature “distortion2” is the part that inflates SGE withdrawals as a measure for demand, “scrap” is supply from sold fabricated products like old jewelry, and “disinvestment” is supply coming from investment bars sold directly to refineries making its way to the SGE.
As a consequence, these new insights regarding scrap and disinvestment supply have changed my perspective on the Chinese supply and demand balance.
To reach a more clear understanding of what was just described, I’ve conceived an exemplar graph to visually interpret the Chinese physical gold supply and demand balance. Have a look.
As you can see in the graph above total supply and total demand are exactly equal, this is because one cannot sell gold without a buyer or buy gold without a seller. Consequently we can gauge demand by measuring supply. Please note, in the supply and demand balance shown above, and in our further investigation, two elements are left out. On the supply side I left out stock carry over in SGE vaults from previous years, as this information is not publicly available. On the demand side I left out gold bought at the SGE that was not withdrawn from the vaults, as this information is also unknown.
In all its simplicity the example chart shows that the difference between consumer demand and true Chinese gold demand is caused by direct purchases from individual and institutional clients at the SGE. While GFMS merely counts demand at retail level, by jewelry and bar sales at shops and banks, the real action is at wholesale level, at the SGE.
GFMS fully neglects direct purchases at the SGE (demand) and any corresponding disinvestment to the SGE (supply). Hence our disagreement.
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Exhibit 8. Download methods: iOS and Android mobile phone users can scan the QR code and open it in the browser to download and install directly.
The China Gold Association (CGA) makes yearly estimates of direct purchases at the SGE. In their Gold Yearbook 2013 direct purchases (net investment) were assessed at 1,022 tonnes, computed as SGE withdrawals minus consumer demand. The CGA neglects any distortion flowing through the SGE hence I stopped using their methodology. Have a look at the screenshot below.
Unfortunately me personally can’t exactly compute true Chinese gold demand, as I don’t have business relationships with all Chinese refineries to gauge disinvestment supply flowing to the SGE. In any case, these are the formulas:
True Chinese demand = net import into the Chinese domestic market1 + scrap + disinvestment + domestic mine output
Although a tad complex, the exact formula including SGE withdrawals is:
SGE withdrawals = net import into the Chinese domestic market1 + (domestic mine output – domestic mine output that not flows to the SGE) + (scrap – scrap that not flows to the SGE) + disinvestment + distortion + (an amount equal to “domestic mine output that not flows to the SGE + scrap that not flows to the SGE” being disinvestment or distortion)
Although not all scrap as disclosed by GFMS ends up at the SGE, it’s definitely all genuine supply and therefore useful in the first formula above. Same goes for domestic mine output.
The part of scrap and domestic mine output that doesn’t travel to the SGE (although being genuine supply) must be replaced by either disinvestment or distortion at the SGE (exhibit 4). Note, in the knowledge direct purchases from the SGE are immense in China (exhibit 9) we can safely assume that disinvestment flows to the SGE are sizable as well.
My new insights unfortunately do not imply that we can make a more precise estimate of true Chinese gold demand. However, I think the best approach is to set the lower bound of true Chinese gold demand at net import1 + mine output + scrap. While I think true demand is likely higher because disinvestment to the SGE can be significant.
Sadly because disinvestment is unknown, distortion is also unknown (exhibit 4)
Let’s return to our discussion with GFMS. The big question is of course, how can total Chinese gold demand by GFMS be 867 tonnes, in a market where mining output accounted for 450 tonnes (source), net imports by my calculations accounted for 1,575 tonnes1, and there is also scrap and disinvestment supply, but export is prohibited and the premium on gold in China was positive throughout the whole year?! This cannot be.
I would like to show a real life example to illustrate what’s going on the Chinese gold market: In 2015 the Chinese stock market (the Shanghai Composite Index) declined by 40 % from June till August. Seeking for a safe haven the Chinese bought physical gold en masse directly at the SGE; some weekly withdrawals in July, August and September transcended 70 tonnes. The gold was of course sourced by imports (look at the premium in exhibit 10), yet GFMS doesn’t consider this to be demand.
Although true Chinese demand cannot be less than SGE withdrawals minus distortion, GFMS pretends their arguments can explain the gigantic gap between SGE withdrawals and consumer demand. Illustrated in the chart below.
All arguments presented can only explain the size of distortion (exhibit 4), not the difference between SGE withdrawals and consumer demand! Actually, I should stop writing here, but I won’t. Let’s briefly go through these arguments to see if they make any sense.
The chapter in question, “A Review And Explanation Of How China’s SGE’s Withdraw Numbers Are Impacted By Other Trading Activities” (Gold Survey 2016), surprisingly lists three new arguments…
Tax avoidance (page 56).
Financial statement window dressing (page 58).
Retailers selling unsold inventories directly to refiners (page 58)
…and one old argument:
Gold leasing activities and arbitrage opportunities (in China gold is money at lower cost) (Gold Survey 2016, page 57, Gold Survey 2015, page 78)
Given the fact GFMS has gone all out in this chapter one would assume it to be complete. But strangely, arguments presented in prior Gold Survey reports and at forums have been abandoned. The following arguments were presented by GFMS in recent years:
Chinese commercial bank assets to back investment products. “The higher levels of imports, and withdrawals, are boosted by a number of factors, but notably by gold’s use as an asset class and the requirement for commercial banks to hold physical gold to support investment products.” (Gold Survey 2015, page 78).
Defaulting gold enterprises sent inventory directly to refiners and SGE (Gold Survey 2015 Q2, page 7)
What happened to arbitrage refining as described by GFMS Senior Precious Metals Analyst Samson Li at the Reuters Gold Forum in 2015? Has this arbitrage opportunity ever existed or did the market change and now the opportunity is closed? I never thought this argument was very compelling. Maybe GFMS changed its mind on arbitrage refining.
What happened to the round tripping of gold between Hong Kong and Shenzhen, put forward in the Gold Survey 2014 and 2015 as a reason that inflated SGE withdrawals? Did criminals stop using this scheme, or did GFMS find out it never inflated withdrawals because gold flows through Free Trade Zones are separated from the Chinese domestic gold market and the SGE system1? In several posts I’ve extensively shown round tripping does not inflate SGE withdrawals, for more information click here.
What happened to the argument Chinese commercial banks buy and withdraw gold at the SGE to back investment products they offer to customers, a practice which boosts import and withdrawals but was not considered demand by GFMS? Or is it demand now, as GFMS dropped this argument from the list? Ok, gotcha.
Now briefly about the new arguments listed by GFMS in the GS2016:
The definition of tax avoidance is that it’s a legal way to pay as little tax as possible. However, the scheme GFMS describes in the GS2016 report is tax evasion, which is highly illegal, and worst case the perpetrator can suffer life imprisonment. This is not some legal loophole as GFMS purports (page 56).
We initially became aware of the scheme in 2013 when it first emerged, but based on information gathered from our contacts, the number of industry participants mushroomed in 2014 and 2015 as other traders became aware of the potential loophole.
By writing the scheme is a way of tax avoidance and a loophole GFSM is misleading their readers. In addition, this illegal scheme did not emerge in 2013. The tax rules are now the same as when the SGE was erected in 2002. In fact, if you click here, you can read an article about the same crimes in 2009. But as mentioned before, we’ll save the details for a forthcoming post, when we’ll also address “financial statement window dressing” and “retailers selling unsold inventories directly to refiners”.
About gold leasing that would inflate SGE withdrawals, I’ve written numerous blog posts about this in the past. Best you can read my post Chinese Commodity Financing Deals Explained. In all the posts I’ve written over the years on the subject I’ve stated that the gold leased is not likely to leave the SGE vaults except when the gold will be used for jewelry manufacturing (which is genuine demand). Effectively, all the gold leasing by enterprises, investors and speculators to acquire cheap funding happens within the SGE system and do not inflate withdrawals. Ironically, in the latest World Gold Council (WGC) report it’s written [brackets added by me]:
Over recent years we have observed a rising number of commercial banks participating in the gold leasing market. … It’s estimated that around 10% of the leased gold leaves the SGE’s vaults. The majority is for financing purposes and is sold at the SGE [and stays within the SGE vaults] for cash settlement.
So, I hope to have clarified why according to my estimates true Chinese gold demand in 2015 must have been north of 2,250 tonnes (import 1,575 tonnes, mine output 450 tonnes, scrap supply 225 tonnes). More details in the next post when we will discuss the tax scheme.
1. Estimating China’s net gold import is difficult. For one, because China’s customs department doesn’t publicly disclose its cross-border trade statistics for gold so we depend on bullion export data (HS code7108) from the rest of the world. Data from Hong Kong, the UK, Switzerland, the US, Canada and Australia is publicly available, but for example data from South Africa is not. Therefor provisional data on China’s net import is not always fully accurate. Only when the CGA publishes the import amount in their Gold Yearbook can we know for sure. My estimate is 1,575 tonnes for 2015.
Net bullion exports to China in 2015: Hong Kong 861 tonnes, Switzerland 292 tonnes, the UK 285 tonnes, the US 6 tonnes, Japan 5 tonnes, Australia 124 tonnes, Canada 3 tonnes.
In China gold is not allowed to be exported from the domestic market (SGE Main Board). However, gold is allowed to be imported into / exported from China through processing trade, usually done in Free Trade Zones. This is the only way gold can be exported from China. Note, processing trade flows are completely separated from the Chinese domestic gold market. For detailed information read my post Chinese Cross-Border Gold Trade Rules.
In order to track how much gold China is net importing, it’s necessary to net out bullion export to China by foreign countries, with import from China by foreign countries (HS code 7108). Although, it’s also possible that bullion is imported into China through processing trade and exported as jewelry (China has a vast jewelry manufacturing industry), which falls under a separated trade category (HS code 7113). Suppose, a jewelry manufacturer in Shenzhen import 2 tonnes of gold from Hong Kong under HS code 7108 through processing trade, processes the gold into jewelry to subsequently export the finished products back to Hong Kong under HS code 7113. This would blur our view on net bullion import by China, however I neglect this phenomenon in my calculations.
The fine gold content in jewelry exported from China (HS code 7113) is very difficult to measure as the total value of the products shipped also contain other precious metals, gems and includes the fabrication costs. Hence, the value and weight of jewelry exported from China does not reveal the fine gold content. The reason why I do not adjust net bullion inflows into China by jewelry outflow is because the gold content in jewelry exported from China is roughly offset by imports of gold doré or gold as a by product in ores and concentrates.
For example, the most recent CGA Yearbook in my possession, covering calendar year 2014 (exhibit 13), states “Chinese domestic and overseas gold mining output” was 512.775 tonnes. In the same report it’s mentioned “domestic mining output” accounted for 451.799 tonnes, implying overseas mine supply accounted for 60.976 tonnes. And thus, I net out overseas mining imported into China (60.976 tonnes) against jewelry exported from China. If I find more information on Chinese cross-border gold trade flows I will adjust my methodology accordingly.
Last but not least, gold can be imported through processing trade into the Shanghai Free Trade Zone (SFTZ) where the Shanghai International God Exchange (SGEI) vaults are located. Potentially, this gold in SGEI vaults, once sold to foreigners is withdrawn and exported abroad (inflating SGE withdrawals). However, a source at ICBC has indicated to me that regarding physical flows the SGEI is mainly used by Chinese domestic banks to import gold into the Chinese domestic market, at least this was the case until December 2015. So I don’t see a possibility there were exorbitant large volumes of gold in SGEI vaults in 2015, or have been withdrawn and exported.
The only noteworthy imports from China (the SGEI) I have observed are by India, which has taken in 370 Kg during 2015 (source Zauba), and by Thailand that presumably bought 7 tonnes (source COMTRADE).
2. For the sake of simplicity I have categorized under “distortion” everything that is not true demand, namely: process scrap, stock inventory change, arbitrage refining (if it exists), the VAT scheme, smuggling and SGEI withdrawals.
On a firmly rising gold price the UK is one of the largest net importers of gold in 2016. The gold price went up 25 % from $1,061.5 dollars per troy ounce on January 1 to $1,325.8 on June 31. Over this period the UK net imported 583 tonnes and GLD inventory mushroomed by 308 tonnes.
In the month of June the UK gross imported 154.2 tonnes, up 22 % from May, and gross export was 1.9 tonnes, down 37 % from the previous month. Net import into the UK resulted in a robust 152.3 tonnes, up 23 % month on month.
Gross import by the UK from Switzerland remained resilient at 68.5 tonnes, up 11 % from May, while gross export to Switzerland was nix.
The most noteworthy gold exporters to the UK in June 2016 were:
Notable, the UK net imported a record amount from China mainland at 3.2 tonnes. This is very exceptional and has never happened in recent history, as far as I know.
The establishment and development of China’s gold market marks the basic completion of the construction of a market for major financial products in China, which will provide better micro grounds for China’s macro economic adjustment. For further development, China’s gold market should gradually realize three transformations: from commodity trade to financial product trade, from spot transactions to futures transactions, and from a domestic market to integration with the international market.
…. gold still has a strong financial nature and remains an indispensable investment tool. In major financial centers in the world, the gold market – together with the money, securities and FX market – constitutes the main part of the financial market.
China’s gold market must integrate into the global market. …. China should actively create conditions for its gold market to become an important part of the international gold market.
… gold still bears the marked nature of money under the modern financial system.
This enables us to better execute on our strategy to become one of the largest Chinese banks in the precious metals market.
Is it a coincidence that China is suddenly exporting gold to the UK while ICBC Standard Bank was recently accepted as clearing member of the LPMCL and utilizes a gold vault in London? Likely the gold export to the UK is connected to the new clearing and vaulting activities by ICBC Standard Bank. Next to China’s strategy to develop the SGEI for gold trading in renminbi along the Silk Road, they’re actively increasing presence in the London Bullion Market.
However, I don’t think the majority of gold imports into the UK this year – aside from the import from China – are connected to ICBC Standard Bank, the imports mainly reflect Western institutional demand. Net gold flows through London have been correlated to the price of gold long before the Chinese entered the international precious metals construction.
So, although the 3.2 tonnes exported from China to the UK are exceptional, the UK manifesting itself as a net importer while the price is rising is quite normal.
The Gold Price And Global Flows
Here’s a theory hopefully sparking fruitful debate: the gold price is set by physical supply and demand in the West.
Since 2013 when the price of gold declined significantly in all major currencies, we’ve witnessed a massive exodus of physical gold from West to East. In 2013 the UK, housing the London Bullion market, net exported 1,424 tonnes, the highest amount since 1997 when 2,473 tonnes were net exported (source James Turk).
In the 2014 and 2015 the UK continued to be a net exporter. Large wholesale 400-ounce London Good Delivery bars were mainly transported to Switzerland, where being recast into 1 Kg 9999 fine bars for the Asian market. From international merchandise trade statistics we could clearly track the gold flowing from the UK, to Switzerland, to Hong Kong, finally reaching China mainland. We could even see a correlation between UK net export and SGE withdrawals from early 2013 up until December 2015.
Currently China is still buying gold, albeit less than in recent years, but the West has turned into a net buyer as well, pressuring supply and forcefully driving up the price.
Some commentators in the gold space deemed it impossible China was importing 1,400 tonnes on average in the past three years while the price was going down. The price was set purely in the paper markets, so they concluded. According to my analysis China was able to buy the tonnages they did by the willingness of the West to supply the metal – exactly who in the West was so eager to supply is another story.
The falling gold price from 2013 until 2015 and the exceptional tonnages China was importing were caused by strong physical supply from the West. Simplified, if 1,400 tonnes are imported into China, one can observe strong demand, but the corresponding supply had to be at least equally strong (or stronger) on a declining price. The nominal volumes of supply and demand are always equal, the difference in strength between both is what sets the price. In my logic, that is. What happened in the past years was that the Chinese were merely buying the physical supply coming from the West, buying as much as they could. A once in a lifetime opportunity.
Remember, if you see 1,400 tonnes being moved into China, that’s a lot of demand, but it’s a lot of supply as well
As stated in a previous post I think the price of gold can be, and is, easily manipulated through derivatives in the short term. Through leveraged futures contracts or derivatives in the highly opaque OTC market the price of gold can be efficiently managed for short periods. But in the long term the price can only be decided by physical supply and demand. If any entity for example desires to suppress the gold price in the long term then physical metal has to be supplied into the open market or an undeniably vivacious spread will appear between the paper and physical price.
What I’m seeing is that physical gold flows across the globe are highly correlated with the gold price. Have a look at the chart below showing the gold price versus the net flow through the UK (and GLD inventory change). There’s a clear correlation.
The same correlation can be seen in net gold flows through Switzerland – which can be considered as a proxy for Western demand just like net flows through the UK.
In general, every time the West starts hoarding in the UK and Switzerland the price goes up, and when they sell the price declines. I think these charts show that there is more correlation between the gold price and physical supply and demand than is widely assumed in the gold space.
Take this last chart for example. The UK net importing huge amounts of physical gold coincides with the price going up, and exactly when they turn to net exporting the price goes down. So then how can the price have nothing to do physical supply and demand?
On a small side note. I find it remarkable that research (by Ronan Manly, BullionStar, and Nick Laird, Goldchartsrus.com) pointed out that the physical float in London was nearly running out in late 2015 and shortly after the UK starts net importing and the price goes up. When in December 2015 the UK net exported 184 tonnes of gold, which was the third highest amount on record, I wrote In February 2016 [brackets added by me]:
When there is no more gold left in London to export, the gold price is likely to go higher on strong global demand induced by economic headwind.
How much gold is left in London? We can make a rough estimate, ….Research by Ronan Manly … and Nick Laird … pointed out there were roughly 6,256 tonnes of gold in London in June 2015. However, of this total at least 3,779 tonnes was monetary gold owned by central banks around the world stored at the Bank Of England (BOE), which is [presumably] not for sale. The remaining 2,477 tonnes in non-monetary gold were potentially for sale. [Note, this number included 1,116 tonnes in ETF gold outside BOE vaults and 1,355 tonnes stored within BOE vaults, leaving 6 tonnes in the LBMA system outside the BOE]
Chinese wholesale gold demand, as measured by withdrawals from the vaults of the Shanghai Gold Exchange (SGE), reached a sizable 973 metric tonnes in the first half of 2016, down 7 % compared to last year.
Although Chinese gold demand year to date at 973 tonnes is slightly down from its record year in 2015 – when China in total net imported over 1,550 tonnes and an astonishing 2,596 tonnes were withdrawn from SGE designated vaults – appetite from the mainland is still the greatest of all single nations worldwide. At the same time the mainstream consultancy firms (World Gold Council, GFMS, Metals Focus) continue portraying Chinese gold demand to be roughly half of SGE withdrawals, as these firms measure “gold demand” merely at retail level which excludes any direct purchases at the SGE by institutional and individual investors. But to reassure you, Chinese wholesale gold demand still equals SGE withdrawals.
In the month of June (2016) SGE withdrawals accounted for a robust 139 tonnes, although this was down 29 % from June last year. The reason being for “somewhat subdued” Chinese gold demand in recent months is that the price of gold has risen strongly over this time horizon and the Chinese tend to buy gold when its price goes down, in contrast to Western investors that buy gold when the price goes up. From 1 June until 30 June 2016 the price of gold in US dollars jumped by 9 % from $1,214.70 to $1,325.76. Over the first six months of 2016 the price of gold exploded by 25 % (from $1,061.5 on 1 January 2016). So, since January this year when the price of gold started to rise, the Chinese actually stepped down their gold purchases while Western demand, which can be roughly measured by the net flow in/out of the UK, went up impressively.
Let us have a look at a few charts to come to grips with what’s going on in the Chinese (and international) gold market. Below, we can see a chart showing monthly SGE withdrawals plotted against the end of month price of gold in yuan per gram. In recent years, whenever the price of gold goes down the Chinese step up their purchases (buying the physical supply coming from the West) and whenever the price of gold goes up the Chinese slow their purchases.
By looking at a weekly SGE withdrawals chart (from before January 2016) we can see the trend just described – “the Chinese tend to buy more gold when the price goes down” – in a more granular fashion. Have a look below.
In contrast to Chinese gold buying behaviour, let us have a look at gold demand from the West. Our proxy for Western demand is the net flow in/out of the UK where the London Bullion Market (LBMA) and the world’s largest ETF’s such as GLD store physical gold. At the beginning of 2016 (when the price of gold started to rise) the direction of the flow has reversed sharply, from the UK being a net exporter to being a net importer.
From being a large net gold exporter in 2013, 2014 and 2015, the UK is now one of the largest net importers. In April 2016 the UK net imported 195 tonnes of gold – while export to China was nil.
If we look at a chart that reflects the net flow of gold into the UK versus the gold price, we can clearly see the correlation. A declining gold price (blue line) coincides with the UK net exporting gold (black line) and vice versa.
The impressive gold rally year to date, and the accompanied massive growth in GLD inventory in London, predicts sustaining net gold imports by the UK in May and June. In a forthcoming post we’ll discuss more thoroughly how above ground gold stock is moving between which nations and how this correlates to the price of gold.
International merchandise trade statistics always lag a few months, so I don’t know exactly the total amount of gold China has net imported in H1 2016. That I know of, China has net imported 368 tonnes year to date, according to trade data from Hong Kong covering January-April, the UK covering January-April and Switzerland covering January- May. Australia’s export data is not clear yet. If we project the pace of imports to to six months, China has “at least” imported 512 tonnes of gold in H1 2016.
Supply to the SGE can only come from import, domestic mine output or scrap/disinvestment. As, import accounted for 512 tonnes and domestic mine supply for 225 tonnes, consequently scrap/disinvestment through the SGE must have been approximately 236 tonnes in H1 2016.
By using our preliminary estimate of 512 tonnes for China’s net import in H1 2016 and mine output at 225 tonnes, there are currently an estimated 18,444 tonnes of gold within China. Assuming the PBOC has accumulated about 4,000 tonnes by now which has not been supplied through the SGE, that is. For a detailed explanation how I conceived this estimate please read my post “PBOC Gold Purchases: Separating Facts from Speculation”.
If my speculative estimate of PBOC holdings would be incorrect, and China’s central bank holds what is officially disclosed at roughly 1,800 tonnes, there are currently an estimated 16,244 tonnes of gold within China.
Nomura’s SGE Withdrawal Data Is False
Since I’ve been publishing SGE withdrawals and its relation to Chinese gold demand many others have jumped the bandwagon, though some more successful than others. A few days ago I stumbled upon a “SGE withdrawals chart” from Nomura research with false data.
In Nomura’s chart it’s shown that withdrawals from the vaults of the SGE in the first five months of 2016 accounted for 4,425 tonnes. Which of course is false. If that would be true, China should have imported about 3,800 tonnes in five months. No, that did not happen.
What Nomura did is grab the “cumulative delivery amount” from the Chinese Market Data Monthly Reports, instead of the “cumulative load-out volume”.The latter is how the SGE refers to “withdrawals” in English. As I’ve written previously the “delivery amount” is not the same as “load out volume”. The “delivery amount” reflects the volume of gold that changes ownership inside the vaults, computed as the sum of the trading volumes in physical products and the contract delivery volumes of deferred products, whereas “load out volume” tells to the amount of gold that is withdrawn from the vaults.
Let’s have a look at the Chinese Market Data Monthly Report from May, which Nomura used for its withdrawal data for January-May 2016 (“5M16” in their chart).
We can see that at number 4 the “cumulative delivery amount” notes 4,425,035.28 Kg, which is exactly what Nomura shows in its chart as “withdrawn”.
By and by, the “cumulative delivery amount” is counted bilaterally. Effectively, half of this amount (2,212,517.64 Kg) is how much physical gold changed ownership inside SGE designated vaults from January until May 2016.
At number 8, we see the actual amount of gold withdrawn from the vaults over this period (counted unilaterally). In the first five months of 2016 SGE withdrawals accounted for 835 tonnes.
Below is the full explanation of the Chinese trade table.
1) Delivery amount this month, the sum of the trading volumes in physical products and the contract delivery volumes of deferred products for the reported month, counted bilaterally in Kg.
2) Trading volume this month, the sum of all trading volumes in physical and deferred products for the reported month, counted bilaterally in Kg.
3) Delivery ratio this month, the proportion of the delivery amount to the total trading volume of both physical and deferred products for the reported month (1 divided by 2).
4) Cumulative delivery amount, the sum of all monthly delivery amounts from the beginning of the year to the statistical time point, counted bilaterally in Kg.
5) Cumulative trading volume, the sum of all trading volumes in physical and deferred products from the beginning of the year to the statistical time point, counted bilaterally in Kg.
6) Cumulative delivery ratio, the proportion of the cumulative delivery amount to the cumulative trading volume of both physical and deferred products from the beginning of the year to the statistical time point (4 divided by 5).