There’s some evidence that what we have is the second coming of the London Gold Pool in the form of very sophisticated financial engineering. Let me just point out that most of the price-setting for gold is done on the COMEX, which is a well-known institution where billions and billions trade daily in gold (and a lot of other things). If you look at the COMEX trading in gold, almost none of it is explained by people who want to actually buy physical metal. You look at the deliveries out of COMEX on a monthly basis, and they’re minuscule. It’s really a paper game. The same is true in London. Those two markets, London and New York, are essentially synthetic gold markets. They don’t really reflect supply and demand for the physical metal. It’s not very difficult to dump billions and billions of dollars of gold on the market -- even if you don’t have it.
When you short something in the stock market, you’ve got to borrow it. You have to control what you’re selling. That’s not true on COMEX. You can short gold without having borrowed any. And that is what I think has happened over the last few years. First, gold went into a correction, so there was an established downtrend. Then it became more and more of a macro playpen for hedge funds, for high-frequency traders, commodity speculators, and a wide variety of other institutions. Then you began to see expectations that the Fed was going to raise interest rates -- and of course they never have. Maybe they will, but I’m on the side that would be suspicious. Merely a few words from the Fed minutes, the FOMC, Yellen speaking, talking about raising rates, in a way has given people who are on the short side of the synthetic gold trade the fortitude to look at shorting gold as essentially a riskless trade.
The question whether there’s government involvement I’ll leave to the conspiracy theorists. But the fact is that you have a synthetic market where you can completely ignore supply and demand fundamentals and simply view gold as a way to position yourself according to your macro view of the world. Gold has provided a very cheap source of carry for these long positions -- again, macro-oriented, but taken in complete disregard for fundamentals.
But take a look at the consumption of gold for the last several years running. Note that consumption measured by offtake in the parts of the world where they don’t play in the derivative market -- India and China being the big players there -- is substantially more than the amount of gold that’s being produced every year. And if you start looking at the migration of gold in vaults, you’ll see it’s all going to Asia and being refined in Swiss refineries. Not into 0.999 purity 400-ounce bars, which is London Good Delivery, but into 0.9999 purity kilo bars. This is well-documented. And in addition you’ve had substantial disappearance of gold from Western vaults -- London being the least transparent because there are probably 50 vaults in London. Nobody really knows.
OR: What’s the significance of the increase in refining into smaller increments?
Hathaway: Well, once it’s refined into four-9’s kilo bars instead of three-9’s 400-ounce bars, you can’t claim it with paper in the synthetic gold trade because it’s not London Good Delivery. What it points to is that the underlying physical upon which this pyramid of credit for synthetic gold is built is getting smaller and smaller.
Now how does that play out? I don’t think anybody can really know for sure, but at some point the market for gold will be influenced more by what is going on in Asia, which is the offtake. The Shanghai Gold Exchange numbers seem to be fairly accurate. Those numbers are fairly transparent.
Where I think I’m getting to on this is that there’s substantial evidence that China is ramping up its exposure to gold. We know the Chinese government has been buying surreptitiously and not reporting what they have since 2009. They announced in mid-July a 57 percent increase in their holdings over the last reported figure in April of 2009. This looks a little on the low side to me. Three possible interpretations seem likely. One, they are still underweight and therefore have more to buy. Two, there is a gray area between official-sector and quasi-official institutions. It wouldn't surprise anyone if they had parked a good deal of physical away from the official PBOC balance sheet. Three, this could just be cosmetic -- a part of their campaign to elevate the RMB to SDR status.No matter the immediate motive for its accumulation, gold is still for them a hedge against the vast amount of U.S. low-yielding/non-yielding treasuries. But with the arrival of the Shanghai Gold Exchange, there’s a mechanism now for recycling some of those trade surpluses they have with the rest of the world into something besides U.S. treasuries -- and that’s gold.
We know that Russia is selling its oil and natural gas to China -- not for U.S. dollars, but for RMB and gold. We know that Saudi Arabia is selling oil to China, and to some degree the settlement is in gold. Gold is sneaking up on us and reentering the international trade picture to the detriment of the dollar.
I’m not saying the dollar is going to go away. The dollar is still going to be a hugely important reserve currency, but there are some chinks in the armor and some erosion at the fringes. And this is being achieved basically because gold allows the recycling of large amounts of trade surpluses away from U.S. dollars. I think this is a space to watch and that’s why there’s some relevance and importance to the displacement of Western above-ground gold stocks to Asian markets.
Is this going to lead to an explosion in the gold price? I don’t necessarily think so, but I do think that when something occurs which leads Western investors who have been shorting paper gold to turn around and want to own gold as they did from 2000 to 2011, there are underlying forces shaping up in the gold market that could result in an even more dynamic upside leg than what we had from 2000 to 2011.
John Hathaway co-manages the Tocqueville Gold Fund and is widely considered to be a leading voice on the subject of gold and precious metals.