WGC Continues Not to Understand Gold Market

The WSJ recently reported on the latest gold supply-demand report issued by the World Gold Council. It isn't really a surprise to us, but it is nevertheless astonishing that an organization that is supposedly focused on gold can get the market's most fundamental aspects so utterly wrong. The WSJ article is entitled “Global Gold Demand Down 16%”.That sounds like a lot, right? Here are excerpts from the article:

“Global demand for gold slumped in the second quarter as Chinese and Indian buying returned to more stable levels following a record-breaking quarter a year earlier, the World Gold Council said Thursday.

"This is a gold market that is returning to balance," Marcus Grubb, managing director of investment strategy at the World Gold Council said in an interview. "These figures reflect the exceptional quarter that was second quarter last year where we had large outflows in exchange-traded funds on the one hand and a very significant increase in physical buying on the other."

China and India, which together account around half of global gold demand, purchased 193 tons and 204 tons of gold, respectively, in the second quarter—a sharp drop from a year earlier.

Total demand for gold was 964 metric tons in April to June, down 16% compared with 1,148 tons during the same period in 2013, the industry body said in a quarterly report. Demand for gold used in jewelry dropped by almost a third to 510 tons in the second quarter, from a year before.

The World Gold Council expects India to buy between 850 and 900 tons of gold this year, down from 975 tons last year. China is expected to buy between 900 and 1,000 tons, down from the record 1,275 tons of demand last year.

Central banks, meanwhile, bought up a net 118 tons of gold in the second quarter, a 28% jump from the year before. The main buyers were the central banks of Russia and Kazakhstan, reflecting the appetite of emerging-market countries for a hedge against dollar exposure in their reserves.

After the sharp selling in the second quarter of 2013, investments in the latest quarter rose by 4% in the three months through June, to 235 tons, reflecting more stable demand for exchange-traded funds, the WGC said.

"Investors are now comfortable owning gold again in the form of ETFs and we've seen a very significant stabilization," said Mr. Grubb.

Overall supply of gold to the market—including mine supply, recycling and producer hedging—rose 10% in the second quarter to 1,078 tons, while mine production rose 4% to 765 tons, according to the WGC.

(emphasis added)

Many have pointed out how little sense these statistics make, but to keep it as simple and possible, so that even the odd WGC statistics minion who might read this understands it: the total gold supply is actually approximately 175,000 tons. Guess what the total demand is…right, it is 175,000 tons as well. What the WCG declares to be the “overall supply last quarter” is merely what was added to the total supply of gold.

Naturally, investment demand was not a mere 235 tons either (in London alone two to three times that amount trades every single day), but actually represented the vast bulk of total demand, greatly exceeding the paltry jewelry demand of 510 tons.

The WGC insists on analyzing gold as though it were an industrial commodity like copper, which it clearly isn't. Gold is a monetary commodity first and foremost, and is never “used up”. It is inter alia precisely because such a large above-ground supply of gold exists that it is useful as money.

In order to see the total supply-demand picture, one must not lose sight of the largest component of demand, which is reservation demand. This is the demand exercised by current holders of gold who are not wishing to sell at the current price. For a detailed description of how to properly analyze gold market supply and demand, take a look at Robert Blumen's article “What Determines the Price of Gold”.

As a result of the WGC trying to determine supply and demand by analyzing gold with the method employed in industrial commodities, its supply-demand reports are completely useless in determining the likely course of the gold price.

In fact, the likely gold price trend can only be divined indirectly, by analyzing the true fundamental drivers of monetary, resp. investment demand for gold. In other words, the only way gold can be analyzed is by looking at it as a currency – a very special one, the supply of which grows much slower than the supply of any other currency in the world, and that is at the same time the only currency that is not somehow dependent on abstract “promises to pay” issued by governments. This is also why gold has only a paltry yield when lent out – its yield contains no price premium (as it cannot be inflated by central banks, contrary to other currencies).

Test of Support

Gold has incidentally just dipped back to a major support level – but this is definitely not a result of India and China importing a little less of it last quarter. There is one major reason not to worry about this dip too much and that is the fact that gold stocks continue to act well, even on trading days when gold and silver are fairly weak. Of course this may yet change, but it hasn't changed so far. There is also yet another divergence between gold and silver in evidence at the recent low. These divergences have up until now proved to be positive signals, but  we are only looking at probabilities in this context, not certainties. The recent strength in the US dollar and renewed strength in risk assets were likely the main culprits triggering the bout of weakness in the precious metals.

Gold retests a support level. Silver remains above its major lateral support – via StockCharts