In January Steven Saville of The Speculative Investor newsletter wrote an article saying that “focusing on the changes
in gold location is pointless if your goal is to find clues regarding gold’s
prospects.” While I get what he was trying to debunk, I think he has
thrown the baby out with the bathwater in doing so.
His target was specifically those who make the claim that “demand is
rising even though the price is falling”, usually in respect of Chinese
demand. I agree that this is a nonsense statement as for every buyer there is
a seller, so to say that demand is up in China is the same as saying that
supply is up in Switzerland.
Steven is correct that “the price trend is determined by the general
urgency to sell relative to the general urgency to buy” and that price
is the only way to know the relative urgency: “If the price is rising we
know, with 100% certainty, that buyers are generally more motivated than
sellers.”
So who is the baby that Steven threw out in his article? A clue is in this
statement:
“while there could be a reason for wanting to know the amount of gold
being transferred to China (I can’t think of a reason, but maybe there is
one), the information will tell you nothing about the past or the likely
future performance of the gold price”
It is the future price baby. When looking at the past, I could concede
that price is probably all that matters, but when it comes to the future
price, who bought (or sold) I think matters a lot. Steven himself says in his
follow up post that “the most useful information is that which
provides clues about the likely future intensity of buying relative to
selling”.
Let me explain by an example. When I was a kid, football cards were
popular. If you live on the moon, this is what I’m talking about.
I picked the first two names I recognised out of google’s image search.
Apparently people collect these things. When I was a kid we used them to
flick them and play snap type games and they’d get damaged quite a bit, then
I grew out of them and gave them away.
Anyway, according to Steven, all you need to look at is the price of
football cards going up. It is not important to know who was buying, say that
it was a crazy old millionaire who was buying, stacking them in his house and
never selling them – that would apparently have no impact on future prices.
I’d argue that it does matter if the buyers were a wide variety of normal
collectors vs a market dominated by one crazy buyer. I’d like to know if he
was keeping the cards in good order, or whether they were rotting away in a
basement, and how old he was and whether his children had any interest in
cards or would dump them on the market when he died. That seems all pretty
relevant to the “future intensity of buying relative to selling.”
Knowing who was buying in this case would give you an edge on guessing future
football card prices.
To bring this back to gold, it does matter to me to know if the buying in
size was coming from institutions/hedge funds (ETF flows give an indicator of
this) or Chinese/Indians, for example. On the balance of probabilities on
past behaviour, I would not want to make a long term bet on gold prices based
on hedge fund buying as it is only a “trade” to those people and I could be
sure they will sell up at some point.
However, given the known and demonstrated cultural hoarding behaviour of
Chinese and Indians, I would have a bit more confidence that this gold would
not be coming back into the market in the future. On the other hand, if one
thinks that the Chinese economy is going to struggle, then maybe buying will
drop off or even dishoarding will occur. Steve may not care to know estimates
of how much gold is in China or India, but surely the bigger the hoard the
bigger the risk that accumulation may stop (eg China gets enough central bank
gold reserves to get into the SDR) or reverse?
Now while India and China are like black holes for gold consumption, I
would point out that this is price positive only in the long term. It is a
macro factor supporting gold but has less impact on prices in the short run,
which is why if you run a correlation between ETF or Chinese flows to price
you don’t get much. This is probably what Steven is rebelling against, this
simplistic construction of a Chinese demand “meme” as respect to immediate
prices.
The fact that people may be making the wrong assessment about the future
(lack of) selling intensity of current gold holders, or that they are
focusing far too much on short term prices, or that they may be using such
“analysis” to pump their products/services (the bathwater), doesn’t mean not
knowing who the market participants are (the baby) is not important. Reasoned
and considered analysis of the current buyers and sellers and their
motivations I think has some predictive usefulness.
Someone who would agree with me I bet would be HSBC and JP Morgan. As the
two bullion banks with the greatest market share of the gold trade, they have
access to information about where gold is flowing from and to well before
anyone else. I find it hard to believe that seeing orders to buy gold (to
replace sold coins/bars) from The Perth Mint and other mints and
distributors, seeing orders from miners, jewellery manufactures, from scrap
merchants and industry users – that all that “who” information is “pointless”
for future price prediction.
Some people wonder why bullion banks are so successful and the fractional
reserve bullion banking system hasn’t imminently failed. Maybe, just maybe,
that knowing exactly who, when, where and how much is being bought and
sold both in physical and paper markets is information that has value and
gives one an edge.
