Koos Jansen
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Koos Jansen
Posted on 19 Oct 2016 by

The Great Physical Gold Supply & Demand Illusion

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.

screen-shot-2016-10-02-at-10-22-17-pm
Exhibit 1. Courtesy GFMS. Global gold S&D balance as disclosed in the Gold Survey 2016.

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.

global-gold-supply-demand-2013-including-conservative-institutional-supply-demand-1
Exhibit 2. Global gold S&D 2013 by GFMS, including conservative estimate institutional S&D.

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.

uk-gold-trade-vs-sge-withdrawals
Exhibit 3. Correlation between UK net gold export and SGE withdrawals.

Because of the mechanics of the gold market in China, Chinese institutional demand roughly equals the difference between the amount of gold withdrawn from SGE designated vaults (exhibit 4, red bars) and Chinese consumer demand (exhibit 4, purple bars). In the exhibit 4 below you can see this difference that brought GFMS in a quandary, especially since 2013. For more information on the workings of the Chinese gold market and the size of Chinese institutional demand please refer to my post Spectacular Chinese Gold Demand Fully Denied By GFMS And Mainstream Media.

chinese-domestic-gold-market-sd-2015
Exhibit 4. Chinese wholesale demand (SGE withdrawals), versus GFMS consumer demand versus apparent supply.

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.

global-gold-demand-2013-by-gfms-including-apparant-institutional-demand-1-png
Exhibit 5. Global gold demand 2013 by GFMS, including 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 [2013]. 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.

global-gold-supply-demand-2013-by-gfms-including-apparent-institutional-supply-demand-vs-total-lbma-refining
Exhibit 6. Global gold S&D by GFMS, including apparent institutional S&D, versus total refined gold production 2013.

In the table below we can see the LBMA refining statistics for 2013 at 6,601 tonnes.

1-6601-gold-tonnes-1
Exhibit 7. Courtesy LBMA. Screenshot from A guide to The London Bullion Market Association captured by Ronan Manly in May 2015.

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.

2-4600-gold-tonnes-2
Exhibit 8. Courtesy LBMA. Altered document on refining statistics by the LBMA August 2015.

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.
  • The fine details about how often and when the LBMA changed its refining statistics can be read in Ronan Manly’s outstanding post Moving the goalposts….The LBMA’s shifting stance on gold refinery production statistics.

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:

screen-shot-2016-10-10-at-9-38-29-pm
Exhibit 9. Courtesy GFMS. Global gold S&D balance as disclosed in the Gold Survey 2015 Q2. 

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. 

screen-shot-2016-09-30-at-7-39-10-pm
Exhibit 10. Courtesy GFMS. The global 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
  • ETF demand

…versus my what I deem to be a more unadulterated approach of investment demand, consisting of…

  • Retail bar & coin
  • ETF demand
  • Institutional demand

According to my estimates, in 2015 apparent Chinese institutional demand accounted for roughly 1,400 tonnes (exhibit 4). In the Gold Survey 2016 GFMS states on page 15 [brackets added by me]:

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.

global-investment-gold-demand-2015-1
Exhibit 11. Global Gold Investment Demand 2015.

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.

tip-of-the-iceberg
The global gold market. H/t Dan Popescu.

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.

gnb
Exhibit 12. GFMS’ gold market “net balance” versus the gold price. We can quarrel if the “net balance” in 2014 was positively or negatively correlated to the price. I say the correlation was negative as the gold price in 2014 remained flat in US dollars but was up in all other major currencies, in contrast to the “surplus” presented by GFMS.

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.

gpsd
Exhibit 13. GFMS gold market “physical surplus/deficit” versus gold price.

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.

screen-shot-2016-10-17-at-9-14-53-pm
Exhibit 14. Courtesy GFMS.

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.

snb
Exhibit 15. GFMS silver market “net balance” versus silver price, as disclosed in the Silver Survey 2016.
spsd
Exhibit 16. GFMS silver market “physical surplus/deficit” versus silver price, as disclosed in the Silver Survey 2016.

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. 

Conclusion

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.

gold-retail-demand-vs-mine-scrap-supply-vs-gold-price
Exhibit 17. GFMS retail demand, versus mine and scrap supply versus the gold price.

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.

uk-net-gold-flow-vs-gold-price
Exhibit 18. UK net flow versus the gold price.
uk-net-gold-flow-gld-change-vs-gold-price
Exhibit 19. UK net flow, GLD inventory change, gross import and gross export versus the gold price.

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 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, “because it’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.

H/t Ronan Manly, Bron Suchecki, Nick Laird from Goldchartsrus.com

Appendix

Simplified overview gold flows 2015:

global-physical-gold-flows-gfms

Koos Jansen
E-mail Koos Jansen on:

  • http://goldchat.blogspot.com/ Bron Suchecki

    “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.”

    To be fair, PBOC did not buy all that gold in June 2015, they just annouced it then. They had most likely accumulated it over the preceeding 6 years, in which case the best compromise IMO would be to evenly add 25.18t to each quarter’s Net Official Sector figure (no idea if this is what GFMS did or whether they just left it out altogether).

    • Koos Jansen

      That’s true. Your suggestion to evenly spread the official purchases would have been the best way for GFMS (and the WGC, MF and CPM Group) to include the increment into the balances.

  • Paul

    Thank you for posting such an informative and detailed article. Do you have an opinion on what the trading price of gold (in US dollars I guess is easiest for people to understand) would be if the true numbers were ever accurately reported?

    • Koos Jansen

      It doesn’t have an impact on the price per se. It’s just that nearly all gold investors and observers have been lied to for decades, and as a consequence are not understanding the essence of gold.

  • http://churchofsmoke.org/ Jose

    This article completely ignores the velocity of money which is the reason why inflation remains extremely low. The velocity of money gets even worse when it is converted into physical gold which is why it’s difficult to categorize it as currency.

    • Koos Jansen

      As it’s hardly used in everyday spending gold is mostly used for a store of value I would say.

      • http://churchofsmoke.org/ Jose

        So is a battery!

        • Koos Jansen

          Then I suggest you put your savings in a battery.

          • http://churchofsmoke.org/ Jose

            You don’t believe in diversification?

  • rowingboat

    After years of discussing this Koos, we appear to have come full circle. Do you remember replying to me once that “it remains to be seen whether central banks or western investors are supplying the gold East”?

    Pater Tenebrarum originally posted elements of the link below on the Kitco forum many years ago, partly to refute 1990s manipulation theories that the gold price was low despite record jewelry demand. Note the quote in the article from legendary value investor Jean-Marie Eveillard:

    “When we started our gold fund in 1993 – which proved to be six or seven years too soon – I mistakenly thought that my downside was protected by the fact that jewelry demand was fairly vibrant. But I was wrong. I think gold moves up and down based on investment demand mostly.”

    Gold’s relationship with macroeconomic drivers (investment/divestment demand) is actually well known but is ignored or drowned out by the liars and peddlers with sexier explanations. The GFMS data is useful, particularly in combination with the trade data that is now available, but there is much they can’t measure.

    http://www.acting-man.com/?p=35868

    • Koos Jansen

      Yes, I believe we came a long way. Although, regarding the tight correlation between UK flows and the price.
      1) Sometimes correlation is not causation. More research can be done with respect to paper markets.
      2) How come when the West sells and buys, the price moves, and the East is just is a price taker? Is that just the way people buy gold in the East, when the price goes down, when the West is supplying?

      • rowingboat

        I’ll reply early next week Koos. The answer is mainly common sense by examining the magnitude of changes in the flow. Also what the East has done this year is consistent with prior years in the bull market (historic flows through Switzerland). History is repeating itself.

        • Koos Jansen

          I’m looking at the same “magnitude of changes in the flow”. In 1980 the Middle-East was a large seller when London traded at a 40 % premium – same trends as now. But I still think there’s something missing here. https://uploads.disquscdn.com/images/656d5dc9b32434140ace57c33bfd8f4c8e9b162018d19b14f92ad6267e58fcc2.png

          • lai mee robertson

            Fact or fiction, and did it affect gold prices in the early 1970s? Seagrave mentioned that Nixon arranged for $68 billion worth of gold from Marcos to Mao in 1971-72, which paved the way for Nixon’s 1972 visit to China.

          • lai mee robertson

            http://www.acting-man.com/blog/media/2016/10/3-FF-rate-and-Gold-768×398.png “As this chart shows, context is very important. In the 1970s, Fed rate hikes lagged behind inflation expectations and gold prices actually surged in parallel with the FF rate most of the time” -Ganging Up on Gold
            October 17, 2016 | Author Pater Tenebrarum

      • rowingboat

        Look how Swiss exports to the UAE, a major importer in the 1990s, progressively declined as prices rose in the bull market… now in 2016 UAE has flipped to being a major exporter to Switzerland.

        The West is simply more powerful from examination of the cross-border physical flow. E.g. why did the 2013-15 bear market happen? (Just round numbers you could chart this using your own data):

        2009-12 (QE years): India + China imported 1200mt average per annum.
        2013-15: India + China imported 2350mt average per annum.

        So a delta change of +1150mt.

        2009-12: UK + Switzerland imported 1000mt average per annum.
        2013-15: UK + Switzerland EXported 900mt average per annum.

        So a delta change of –1900mt.

        For 2016 prices have risen because UK + Switzerland have a much higher positive delta compared with India + China’s negative delta, let’s say +1500mt vs. –500mt. UK in particular is on track to IMport 1300mt in 2016 vs. 550mt EXport last year.

  • Matt

    GFMS used to call the balance ‘implied institutional investment’ but given the lack of available information this was renamed normal surplus/deficit a few years back. The debate on gold as a flow or stock market has gone on for years – I remember Frank Veneroso pointing out that while it looked like a stock market it seemed to react far too violently to small changes in flow for that to be entirely accurate.

    • Koos Jansen

      As if ‘institutional investment’ is only as large as GFMS’ “net balance”.

      Like I wrote “institutional S&D … in reality makes up for the difference and far beyond.”

      • Matt

        Remember they are only net flows though.

        • Koos Jansen

          Which flows?

          • Matt

            Well everything really. Central banks, ETFs, etc.

  • Long John Dickweed

    Good work Koos. Bringing in what should be basic common sense concepts into the discussion.

    • Koos Jansen

      Thanks. Strangely it took me several years to find some truth in gold supply and demand theory. The firms have really messed up peoples’ heads re this subject.

  • festina

    Best article I have seen regarding the incompleteness of the statistics provided by the gold consultancy firms. How can you draw meaningful conclusions if you only deal with the 3 000 tons and not the 180 000 tons? Its merely the ears of the hippopotamus the consultancy firms are analysing! Researchers have won Nobel Prizes for less.

  • festina

    An interesting table to accompany the Appendix would be one showing how much physical gold moves through the LBMA, the sources and end destinations of such gold and the volumes of paper transactions this engenders.

    • Koos Jansen

      Maybe one day.

  • Daniel Christian Schweizer

    I remember you from articles in which you claimed the PBOC was buying bullion. I called Beijing, having worked as a government consultant and checked forth and back without finding a single proof.

    Now you write that “demand and supply” “naturally” have to be matched for physical bullion. Call mines and you will figure out that this is not so.

    When you quote Swiss refineries running full steem after the first bubble burst in gold in 2013, why you dont quote the managers there now? Or the ones in India, who built some too? They are collapsing and you know that, thats why you once stop in 2013, once in 2015 and just make a happy collage of facts when they where to your taste.

    You know that gold above ground exploded in the last 50 years. Almost every single consecutive year was a mining record (Caterpillar and Co really did their job well, compared to ancient times).

    Whatever statistics you use, above ground per capita (!) is higher than ever.

    (Your) old take, the richer Asians would get the more bullion they bought cannot be found in statistics. The function of gold was never respected by people hammering out stories to increase their own sales. India had no banks. Now, the old gold lending shops in the countryside have bank licences. And what do we see as a result? Right. Falling imports. I know you would claim “but those are compensated by smuggling” – as if there was no smuggling before. There always was. Tax and hidden wealth was the name of the game. Not miraculous mysteries.

    One might clearly say gold is in utmost oversupply. It is held by a few parties (central banks, India [temples, private]) who could derail the marekt instantly. Central banks would not for their own sake. I am not so sure about India. They need the cash in the system, rotation. To them the bigger question is if a short shock in price (down) would finally move the diehards to the counter, tossing their coins in.

    As my statement is sigle-sided, yours was. But I also do not claim that people cheat and lie in their balance sheets and I do not find strange concepts in order to break them down.

    Supply and demand is almost never fully matched in real product worlds. Gold is no exception there. You could ask any beer vendor, detergent salesman or bookshop. This assumption goes the way of the PBOC idea. I wish you lots of success in selling coins and bars.

    Salesman like you did that in the 80ies, too. Buyers back then – if still alive – still pray for just breaking even on their … ridiculous bets on a metal that is never consumed but adds up and acceleratingly so … savings.

    • rowingboat

      “When you quote Swiss refineries running full steam after the first bubble burst in gold in 2013, why you don’t quote the managers there now? Or the ones in India…”

      It’s a fact of life that people talk their book. The West-to-East meme was
      indeed a daily fascination… that was until this flow stopped and went into
      reverse since February this year!
      I calculate 861mt reduction through Switzerland to the East vs. 2015 and most of that pulled into the UK with higher prices resulting in price discounts in the East as demand there fell.
      The latest Swiss trade data for September, the main conduit of physical flow, suggests the situation may be improving as gold prices fall… but not yet back to 2015 levels.

  • eedream

    so if china institutional investor demands more gold in the coming months or years, we can see western quoted gold price decline even more?? a strong USD buys more cheap xauusd? china is the big winners here right?

    • eedream

      also the collapse of COMEX gonna happen too?? replace by SGE instead?

      • eedream

        or will the spot market, and futures market price of gold will decouple more and more with the SGE price of gold, i noticed SGE daily price always higher than the am/pm fix..(maybe due to the CNY decline in value recently boosts more demand in china)

  • Silver Savior

    Well after we get hyper inflation in the dollar then everyone will see just how important gold and especially silver will be.

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