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In a blog post a couple of weeks ago I noted that it's normal
for large and fast price declines in the major financial markets to be
accompanied by unusually-high trading volumes, meaning that it's normal for
large and fast price declines in the major financial markets to be
accompanied by increased BUYING. I then wondered aloud as to why it is held
up as evidence that something nefarious or strange is happening whenever an
increase in gold buying accompanies a sharp decline in the gold price. Right
on cue, ZeroHedge.com (ZH) has just published an article
marveling - as if it were an inexplicable development - at how the recent
sharp decline in the gold price was accompanied by an increase in buying.
As is often the case in the realm of gold-market analysis, the ZH article
incorrectly conflates volume and demand. The demand for physical gold must
always equal the supply of physical gold, with the price rising or falling by
the amount needed to maintain the balance. If sellers are more motivated than
buyers, then price will have to fall to restore the balance. The key point to
understand here is that for every buyer there must be seller, and vice versa,
so the purchase/sale of gold does not indicate a change in overall demand -
it only indicates a fall in demand on the part of the seller and an exactly
offsetting increase in demand on the part of the buyer. It is also worth
noting - even though it should be obvious - that demand for physical gold
cannot be satisfied by paper gold.
Trading in paper gold (gold futures, to be specific) clearly does have an
effect on the price at which physical gold changes hands. The paper and
physical markets are inextricably linked, but this link does not make it
possible for the demand for physical gold to rise relative to the supply of
physical gold in parallel with a falling price for physical gold.
What happens in the real world is that when the futures market leads the
physical market higher or lower it changes the spread between the spot price
and the price for future delivery. For example, when the gold price is being
driven downward by speculative selling in the futures market, the price of
gold for future delivery will fall relative to the spot price. In a period
when risk-free short-term interest rates are being pegged at or near zero by
central banks, this can result in the spot gold price falling below the price
of gold for delivery in a few months' time. This creates a financial
incentive for other operators in the gold market to buy gold futures and sell
physical gold. For another example, when the gold price is being driven
upward by speculative buying in the futures market, the price of gold for
future delivery will rise relative to the spot price. This creates a
financial incentive for other operators in the gold market to sell gold
futures and buy physical gold.
The bullion banks are the "other operators". They tend to focus
on trading the spreads between the physical and futures markets. In doing so
they position themselves to make a small percentage profit regardless of the
price trend and therefore tend to be agnostic with regard to the price trend.
After harping on about the dislocation between the physical and paper gold
markets, a dislocation that doesn't actually exist but makes for good copy in
some quarters, the above-mentioned ZH article moves on to the level of the
CME (often still referred to as the COMEX) gold inventory. To the sound of an
imaginary drumroll, the author of the article breathlessly points out that
the amount of "registered" gold at the COMEX has dropped to a
10-year low and that the amount of "open interest" in gold futures
is now at a 10-year high relative to the amount of "registered"
gold.
The information is correct, but isn't relevant other than as a sentiment
indicator. It's a reflection of what has happened to the price over the past
few weeks and the increase in negativity that occurred in reaction to this
price move. It is not evidence of physical-gold scarcity.
I currently don't have the time to get into any more detail on the COMEX
inventory situation. However, if you are interested in delving a little
deeper you could start by reading the July-2013 article posted HERE. I get the impression that this article was written
in response to the scare-mongering that ZH was doing on the same issue two
years ago.
Thanks largely to the unprecedented measures taken by the senior central
banks over the past few years, there have been many strange happenings in the
financial world. However, the increased buying of physical gold in parallel
with a sharply declining gold price and the reduction in COMEX
"registered" gold cannot be counted among them.
http://tsi-blog.com/blog/blog-default/
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