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Where Is (all that) Gold Going?
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(June 28, 2010) The world seems to be expecting a correction in gold prices, and why not - demand from retail jewelry sales is falling, and supply from gold scrap recycling is at record levels. Yet, the stubborn yellow metal refuses to fall.
They say that bull markets climb a wall of worry, and there is no market more bullish and yet so fraught with pessimistic worries as today’s gold market. Gold has punched its way to new highs several times this month so far, even as commentators correctly point out that its main use, as a raw material in jewelry, is suffering from recession-level jewelry sales from Mumbai to Dubai to Miami.

On the supply side, things are booming. Scrap recovery and recycling are keeping refiners busy, as evidenced by all the “Cash for Gold” hoopla seen on TV and the thousands of new gold-buying shops opening all across the US. The World Gold Council reports that gold scrap recovery went from 982 tonnes in 2007 to 1668 tonnes in 2009. Add that 2009 tonnage to new mine production, and nearly 4,000 tonnes of gold came onto the market last year from those two primary sources.

So why are gold prices at an all-time high? A traditional reading of the gold market would be that the fundamentals of lower jewelry demand and higher scrap supply can only lead to lower prices, sooner or later. But today, the difference is being absorbed by increased investor demand. Exchange Traded Funds (ETFs) holding physical gold took some 617 tonnes in 2009, but increasingly private investors are taking delivery of gold and securing its storage themselves.

An article entitled “For Gold Investors Who Want It ‘To Go,’” in the 6/25/10 Wall Street Journal, details the scramble by banks and private vaults to provide secure storage for the increasing amounts of gold being purchased by individuals and trusts as a long-term currency hedge. While mentioning that actual physical delivery of gold bullion from the Comex is up 39% this year, the article by Liam Pleven and Carolyn Cui notes:

“But many investors don’t trade in the futures market, and have traditionally kept their gold coins and bars in safe-deposit boxes or private vaults, or even stashed under mattresses. Some are skeptical of storing gold with major banks in the wake of the global financial crisis, presenting a business opportunity for smaller investment firms.”

The overriding goal for gold investors today, many of whom are new to gold, is that they either take delivery personally or allow it to be stored in allocated form, rather than as an unallocated obligation of some financial institution. Jonathan Spall, of Barclays Bank, explains:

“There’s much more demand from gold investors for allocated gold… People are attracted to hard assets outside the banking system which do not represent a credit risk to anyone.”

The article mentions Sprott Asset Management of Toronto, which holds some 250,000 ounces in storage with the Royal Canadian Mint on behalf of its Sprott Physical Gold Trust. Also, the World Gold Council announced this week a $9 million investment with BullionVault, a firm in London that stores gold bullion for its clients. (Disclosure: we are listed bullion dealers with the World Gold Council, and have a cooperative agreement with the Council for their international use in advertising of the phrase “Only Gold,’ for which we hold US trademark rights.)

In short, we are seeing gold being taken off the market by private individuals. These people are not really speculators so much as they are refugees from the volatile world of fiat currencies and seemingly endless debt creation. In the face of roller-coaster markets, shaky currencies, and abysmally low interest rates, where is money to go these days? The logical answer for many is gold itself, gold without intermediaries, gold not in the form of Exchange Traded Funds, gold mining funds, futures contracts, or options - but actual physical gold in secure storage.

Most of our customers probably make use of a bank safe deposit box near where they live. Even the smallest box in most bank vaults will hold several hundred thousand dollars worth of gold at a minimal cost, and with maximum security. Others may look for a private storage facility, or for that matter, bury it in their backyard. We often remind our clients that gold ownership’s major function is to help you sleep at night. Please just keep it wherever it causes you the least amount of worry.

If anything, one lesson of the last few years’ financial crises is that there is not much that you can count on any more in the way of fiscal or economic stability, and that gold is a proven stabilizer to smooth over the bumps in your portfolio’s performance. The new buyers of gold over the past few years, and the newer ones that are thinking about joining them now, predominately do not see gold as a speculation, but as a core holding.

Just as central banks hold gold in their vaults to back their currencies, or provide funds for national emergencies, individuals today are doing the same. Yet some commentators on the gold market treat ‘investor demand’ as just a temporary parking place for gold, while treating gold jewelry production and sales as ‘consumption’ as if the stuff was actually disappearing when made into bracelets and necklaces.

Backwards thinking is this. The phenomenon of gold going into private holdings is the real demand trend today. This ‘use’ of gold as the bedrock of an individual portfolio has the effect of taking gold off the market, arguably on a more permanent basis than does its more familiar use as a raw material in jewelry. Judging from the incredible tonnage of old jewelry being recycled lately, jewelry use can hardly be called ‘consumption.’

As long as the world’s fiat currencies continue to be created promiscuously in response to any perceived crisis in the world, demand will be strong for gold. When the concept of money itself comes under attack, a time-honored store of monetary value becomes, for many, not just a speculation, but a necessary core holding.

Nothing is permanent, of course, but it is hard to foresee anything in the near future that would bring much of that privately held gold back onto the market.

 

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