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How do we square the poor price performance of gold these past few years with an increasing physical demand picture? As the writer points out in this linked article, if we compare apples with apples and look at Shanghai Gold Exchange (SGE) withdrawals as a proxy for end-demand you can see that Chinese demand is rising sharply.

SGE figures – do they really equate to Chinese gold demand?

Also he says “Thus global gold demand remains at a huge level, probably well in excess of newly mined production plus scrap which makes recent gold price performance anomalous to say the least, giving ever more ammunition to those who firmly believe the price is being suppressed for whatever reason.”

That’s the point we were making yesterday in our investment meeting – if demand is so high, why is price performance so weak? If it’s not suppression (which I don’t discount completely) then it comes back to the irrelevance of annual increments of supply and demand for a monetary metal like gold (where above ground inventory is 50 times annual production). For combustible commodities like energy products, annual (and even monthly) ebbs and flows in demand and supply have a disproportionately large impact on price because the above ground inventory is so small compared to demand levels and the threat of commodity shortages are real.

For gold, however, all the gold ever mined is still available. Now this irrelevance of incremental supply and demand could be changing I think. The crux moment for gold will be when (and if) all the gold ever mined becomes spoken for, or when it’s held so closely to users’ chests that it’s effectively removed from the market – and in an instant gold changes from being priced with no “convenience yield” to having an infinite convenience yield. At that moment, spot gold will trade at a premium to future claims on gold (paper gold) and the spot price could spike astronomically higher. Then even the smallest release of physical gold onto the market will be snapped up by those who need it most (think the shorts who will be called to deliver on their promise to sell at much lower prices!).

There may be plenty of investors who find themselves short gold in this environment, not just those who have sold futures contracts or sold call options. There will also be a sizeable group who previously believed that they had gold, but when the dust settled found out that their claim on gold was no longer deliverable. These participants will then have to re-enter the market to get the exposure they thought they had. The Dutch central banks has made sure this past couple of months that they will not be one of those parties. Well done them for securing their gold reserves more closely (although not completely yet) to home soil. It makes the German effort to have their gold reserves stored on-shore look paltry by comparison.

Let’s hope the Swiss deliver some fireworks this weekend, and 1 month GOFO can keep heading further into negative territory. (last -0.33% p.a.)