Chinese gold demand explodes in reaction to lower gold price
While there has been much fanfare regarding the end of the US Federal Reserve QE3 (quantitative easing) programme, we note that within 2 days of this event, the Bank of Japan (BOJ) unexpectedly announced its latest QE programme – QE9, that will deliver US$100bn+/month (US$1.2+ trillion/year).
In a world where the structural debt issues have been papered over, at least one of the major central banks is required to expand their monetary base to provide the necessary liquidity to fund government deficits and support global asset prices. This may also fuel asset prices (equity and property markets) further, however it increases the financial risks of traditional financial assets and emphasises the benefit of financial asset insurance (gold) within a wider investment portfolio.
The latest Japanese QE announcement has led to a dramatically weaker Yen causing further US dollar strength and weaker gold prices (generally the gold price is negatively correlated to the US dollar). However, the weaker gold price has increased the appetite for physical gold from Chinese consumers, despite PR spin from respected media outlets to the contrary.
See the article below highlighting the significant tonnage of gold that the Chinese and Indian consumers are buying, compared to the very different PR spin that the western financial media attempt to portray.
https://www.bullionstar.com/blog/koos-jansen/the-mainstream-media-versus-gold/
Hayes view - Koos Jansen; a highly-respected and independent European based gold expert, highlights the current discrepancies that we believe require further consideration.
We are mindful that the fundamentals and gold accumulation by Asia, as highlighted in the article above, continues at a increasing pace and the sizable and increasing derivative short gold positions held by the global Hedge Funds could unwind naturally or implode at anytime. As the extreme levels of leverage and derivative positioning in the financial markets grow, the financial risks and volatility in all financial markets will likely increase.
We may be reaching a point where there is not the physical gold bullion to satisfy the Asian demand at the current price. This could create a squeeze driven by the bullion banks (who have covered their short positions) in the cash settled derivative market – the COMEX (US Commodities Exchange). Under this scenario the fundamentals of physical gold supply and demand would overwhelm the Hedge Fund derivative short positions that can’t deliver physical bullion to Asia. The important point to appreciate is that the Hedge Funds have no physical gold, they sell derivative or paper gold on the COMEX and buy US dollars and can only settle in cash.
Global Hedge Funds represent enormous pools of leveraged capital. They position their capital short and long through technically pre-programmed computer algorithms. They are driven by liquidity and momentum rather than fundamentals. Hedge Funds are powerful and need to be respected, but can cause great volatility when they unwind naturally (price targets are met) or implode (disorderly unwind of positions due to an economic event or overriding of fundamentals).
Our research suggests a disconnect is building between the extreme short Hedge Fund positioning in the gold derivatives market that determines global gold price and the tightness in the physical gold supply (from mines) and demand (from Asia). This disconnect may grow larger and the gold price could weaken further if the bullion banks can continue to source additional gold to deliver to Asia, however the risks within the derivative short gold trade are growing, while the gold fundamentals look more compelling.
Because the Yen and the Euro currencies are weak relative to the US dollar (due to Japan’s QE9 + prospect of European QE), Hedge Fund algorithms have been programmed to sell Yen, and buy the US dollar. Relative strength in the US dollar, causes the algorithms to sell derivative gold at the US based COMEX exchange and this weakens the gold price further as we have seen in recent days and weeks.
For this reason gold prices may face further headwinds and Hayes Gold Fund (HGF) has positioned defensively closer to our benchmark (Australian dollar gold) to manage this risk.
Provided the mines and bullion banks can deliver physical gold to Asia there is no problem. However if the bullion banks are struggling to find the physical gold to deliver to Asia because there is already a supply deficit from the gold mines of the world and investors/central banks won’t sell or lease their physical gold, then the paper derivative price must ultimately rise to a point where the delivery stress subsides.
With the gold price now below its marginal cost of production (approximately US$1,200) and gold mines likely to close if price stays below $US1180, this added stress within the global physical market will eventually lead to a higher gold price. Based on the fundamentals that we follow closely, rather than Hedge Fund algorithms, we believe we could be close to a physical disconnect between the currency trades and the gold price.
Further support for gold is likely to come from the new derivative gold exchanges based in Shanghai and Singapore. These gold exchanges are backed by physical bullion and their objective is to rival the London and New York exchanges that are coming under increasing regulatory scrutiny. It is logical that these Asian financial capitals who have become global centres for physical gold trading and storage will want to flex their muscle in terms of their influence on ‘price discovery’ over time.
Conclusion
We anticipate increased volatility in all risk assets during 2015/2016 as more global QE is applied and the derivative imbalances grow larger. Respected monetary organisations are increasingly concerned – IMF, Bank of International Settlements and World Bank, while the BRICS nations prepare for monetary change.
The price of gold has become less reflective of the physical supply (from mines) and demand (from Asia); there is a supply deficit from the gold mines of the world. Daily gold prices are being determined by global Hedge Funds that are currently positioned short gold in the futures and options market as a result of changing currency relationships, determined by global central bank QE policies.
The influences on global gold ‘price discovery’ will likely change as well thought out longer term strategies in Asia led by Singapore and Shanghai seek to shift the balance of power in the bullion markets to where the physical gold is now centred i.e. Asian financial capitals.
The physical gold accumulation from Asia, combined with a global cost of production (approximately US$1200/ounce) that is now higher than today’s gold price and mine closures will determine the longer term outlook for gold, rather than Hedge Funds positioning within highly leveraged derivative markets.
For those looking to grow and protect wealth, rather than provide income, there is more reason to have financial asset insurance in place based on the global macro backdrop. Gold can continue to face near term headwinds and may even fall further, but the cost and opportunity of owning financial asset insurance rather than not, has become compelling.
Craig Robins
CIO and Executive Director
To request an investment statement : info@hayesgold.com
Hayes Asset Management Limited
PO Box 8811, Auckland 1150
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M : + 64 21 620598
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