22 Mar 2017
by Jim Rickards, DailyReckoning:
I consider gold a form of money. That means I investigate price movements in gold the same way I investigate moves in any other global currency — and find the best way for you to play it.
To understand the gold market, you understand physical gold flows.
Visiting with some of the most knowledgeable experts and insiders in the physical gold industry has allowed me to gather extensive information on the major buyers and sellers of gold bullion in the world and the exact flows of physical gold.
This information about gold flows is critical to understanding what will happen next to the price of gold. The reason is that the price of gold is largely determined in “paper gold” markets, such as Comex gold futures and gold ETFs. These paper gold contracts represent 100 times (or more) the amount of physical gold available to settle those contracts.
As long as paper gold contracts are rolled over or settled for paper money, then the system works fine. But, as soon as paper gold contract holders demand physical gold in settlement, they will be shocked to discover there’s not nearly enough physical gold to go around.
At that point, there will be panicked buying of gold.
The price of gold will skyrocket by thousands of dollars per ounce. Gold mining stocks will increase in value by ten times or more. Paper gold sellers will move to shut down the futures exchange and terminate paper gold contacts because they cannot possibly honor their promises to deliver gold.
The key to seeing this gold-buying panic in advance is to follow the flows of physical gold. Once the price of physical gold starts to move up on basic supply and demand fundamentals, the stage is set for corresponding increases in paper gold prices.
As more and more paper gold holders turn from the paper market to obtain physical gold, which is already in short supply in the physical market, we’ll see the beginning of a price super-spike.
As long as supply and demand for physical gold are in rough equilibrium, there is no catalyst for a sudden spike in gold prices, apart from the usual geopolitical flight to quality demand. But, as soon as demand begins to overwhelm supply, then it’s “game on” for significantly higher physical gold prices followed by the toppling of the inverted pyramid of paper gold contracts.
What information do we have about the flows of physical gold that will help us to understand the supply/demand situation? That’s a mixed bag. Some physical gold players are completely opaque and do not report their purchases or holdings transparently. The Chinese and Saudis are the least transparent when it comes to reporting their gold market activities.
On the other hand, the Swiss are highly transparent. The Swiss report gold imports and exports by source and destination on a regular basis.
The Swiss information gives us a window on the world. That’s because Swiss imports and exports are mostly about the Swiss refining business, which is the largest in the world.
There are no major gold mines in Switzerland and Swiss citizens are not known as major buyers of gold (unlike, say, Chinese or Indian citizens). The Swiss watch industry does use a lot of gold, but imports are balanced out by exports; Switzerland itself is not a major destination for Swiss watches.
In effect, Switzerland is a conduit for much of the gold in the world. Gold arrives in Switzerland as 400-ounce good delivery bars , doré bars (those are 80% pure ingots from gold miners), and “scrap” (that’s the term for jewelry and other recycled gold objects).
This gold is then melted down and refined mostly into 99.99% pure 1-kilo gold bars. These 1-kilo “four nines” quality bars are the new global standard and are the ones most favored by the Chinese.
By examining Swiss imports and exports, we can see where the supply and demand for physical gold is coming from and how close to balance (or imbalance) that supply and demand is. This information can help us to forecast the coming super-spike in gold prices. Switzerland does not produce its own gold.
The “big five” destinations are China, Hong Kong, India, the U.K. and the United States. Those five destinations account for 91% of total Swiss gold exports.
Hong Kong demand is mostly for re-export to China. This is revealed through separate Hong Kong import/export figures, which are also considered reliable by international standards. Using Hong Kong as a conduit for Chinese gold is just one more way China tries to hide its true activities in the physical gold market.
Bear in mind that China is the largest gold producer in the world. There is an additional 450 tons per year of indigenous mining output available to satisfy China’s voracious demand for official gold, held by its central bank and sovereign wealth funds.
And China has been a major destination for Swiss gold.
In December 2016 Switzerland exported an astonishing 158 tonnes of gold bullion directly to China. That’s a 168 % increase over the previous December.
In total, Switzerland exported 442 tonnes to China last year, up 53 % from 2015.
Heavy Chinese buying means there’s less physical gold to meet investor demand going forward. That means the price of gold is likely to go up because that’s the market’s solution to excess demand.
Supplies of gold in Switzerland are already tight (I heard this first-hand from refinery and vault contacts there). If shortages worsen, as I expect, there’s only one way to adjust the Swiss gold trade imbalance — higher prices.
Once the higher prices kick in, demand will send it into overdrive. From there, it’s just a matter of time before the whole paper gold pyramid comes crashing down.
And global mining supplies are not expected to increase much over the next few years.
Fewer gold discoveries, lower grades and high extraction costs are constraints on supply growth. This year we could see decrease in global production for the first time in over a decade.
So while demand remains strong, supplies are tight. It’s a recipe for much higher gold prices.
Gold prices are set to skyrocket based on a combination of supply and demand fundamentals and imbalances in the paper gold market. If gold goes up, the prices of gold mining stocks go up even faster.
In effect, buying gold mining stocks is a leveraged bet on the price of gold itself.
I expect the days ahead will present amazing opportunities in select gold miners.
for The Daily Reckoning
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