Long gold holders were taken for a wild ride over the past couple of weeks, enduring one of the largest one day selloffs in history on April 15 as panic gripped the market. By the end of the rout, gold had fallen more than 15% peak-to-trough in just three trading sessions, bottoming out at $1,321.50 (basis June futures), a level not seen since fall 2010. Gold has since rallied smartly (Chart 1), retracing more than $150 of the selloff. What are you to make of such a move?
The selloff in gold has sparked what can best be described as a new gold-rush, as investor clamor to buy physical gold. Evidence of the strong physical demand can be seen in the premiums investors have been willing to pay above market value for access to bullion. Prior to the yellow metal’s “flash crash,” wholesalers in Dubai were paying about 50 cents above the London cash price, and are now paying premiums of between $6 and $9 an ounce. In Istanbul, one of the largest gold trading hubs, premiums have reached as high as $25 per ounce. In China, volumes on the Shanghai Gold Exchange set a new record high last week, and countries from the U.S. to Australia have reported feverish buying of gold coins, causing shortages.
The strong investor demand has not been mirrored in gold ETFs, where we’ve observed a significant decline in the number of ounces held in trust. Since December of last year, total known ETF holdings of gold have declined by about 13%, the largest and most protracted decline since the advent of physically-backed precious metals ETFs.
Aside from thus far unrealized expectations for inflation (at least in official figures) arising from record money-printing around the world, the strongest argument in gold’s favor is the return of central banks to the demand side of the gold market.
For decades, central banks were supplying gold to the market as they diversified away from noninterest bearing bullion into the government bonds of reserve currency countries. Last year, however, central banks added approximately 530 metric tonnes to their reserves, the most since 1964 – and this does not include China, which is believed to be a heavy buyer of the metal. Turkey, South Korea and Brazil all nearly doubled their gold holdings in 2012, and Russia also significantly increased its holdings. Combined, these four central banks purchased 368 metric tonnes through February year-over-year, constituting the bulk of disclosed central bank purchases. At the same time, there were no notable sellers among central banks.
The buying bonanza seems set to continue in the years to come. In Switzerland the Swiss People’s Party, the largest in the Federal Assembly, has collected the 100,000 votes necessary to call a national referendum requiring the Swiss National Bank to hold at least 20% of its reserves in gold. If passed, the proposal would require the SNB to almost double its current holdings by buying more than 1,000 tonnes of the yellow metal.
Long positions are not without risk. The selloff was preceded by news that Cyprus would sell €400 million worth of gold to help finance its bailout. While Cyprus has a relatively small amount of gold, other troubled European states do have significant holdings. Combined, Portugal, Spain, Italy and Greece own 3,228 tonnes.
We remain long-term bulls on gold, and see value at current levels. Volatility is prone to arise, so stops should be placed carefully.