The Structure and Future of Gold in the investment and monetary worldTuesday October 11, 2016 12:28
This article looks at factors that will affect gold and silver prices as we go forward. We have to say they are considerable and will lead to our conclusion that while the gold price has fallen through support below $1,300 and now stand at $1,250, we see the fundamentals taking the price back higher and much higher over time. Indeed we do see it rising through its all time peak in the next year and beyond. We will also highlight the fact that such a rise will occur in all currencies as they weaken against the gold price.
Gold price structure
Not the balance of demand & supply
Few people realize the structure that lies behind the gold price. Most people believe that it reflects the balance of supply and demand. This is based on the belief that up to 95% of supply and demand is matched by buyer and seller in a ‘normal’, with the un-contracted, unforeseen, final 5% [described as the marginal supply] taken to market in search of buyers, by producers. Likewise buyers have normally contracted 95% of their needs direct from refiners or miners. But the final 5% is bought or sold in the market place when the unexpected need arises.
The market that defines the gold price should be made up of marginal suppliers and buyers. Or is that all? No! Speculators and investors turn to this open market in droves. They are the ones that change the game and stop the market being simply unexpected demand and supply. In most simpler markets speculators and investors make up a far smaller percentage than they do in the very different gold market.
Investors in gold come to the market because;
- The price is going to rise or fall and they want to make a profit longer-term.
- They believe gold is money and buy it to hold for the long term, because of their increasing doubts about the value of national currencies against gold, which is in competition with paper currencies as a store of value. Bear in mind that gold has been such for thousands of years, whereas currencies have only been independent of gold as a back-up since 1971.
Speculators come to the physical gold market usually because they want to hold the metal for a short term profit or sell the metal to buy it back lower down [for profit again]. They are often driven by factors outside the gold market, such as changes in exchange rates in various currencies, or changes and expectations in economic factors, such as interest rate movements, on a global basis. They have little interest in the forces underlying gold any more than they have in any other commodity. Profit in the short term is their goal, and if the gold market or any other market can supply that profit, there they will go..
COMEX is not simply a commodity exchange. It is a financial market. The COMEX gold market is not a physical gold market. It is a place where one makes financial bets for cash on contracts, either futures or options.
The only time it becomes a physical gold market is when notice is given by a buyer or seller at the start of a contract that delivery is required or supply will happen at the end of the contract. If no such notice is given then any loss or profit at the end of the contract is paid in cash only. This protects all buyers and sellers and the exchange against having to deliver physical gold.
Remarkably, the physical market is heavily influenced by COMEX and somehow, adjusts prices in line with COMEX. It shouldn’t happen unless there is a link between the use of the physical market with the COMEX ‘financial’ market. This does happen when the banks operate in both markets using them in conjunction to drive prices, causing other investors to react to their actions.
For example, speculators [high frequency traders included] will take short or long positions on COMEX then enter the physical market [in London usually] to deal in physical OTC in such a way as to make their COMEX positions profitable. If they are short [as we saw on last Tuesday] they sell enough gold to depress the price. On quiet days, such as when the Chinese market was closed last week, it was a good time to sell using both markets [when buyers, in size, were absent] to manufacture short-term profits.
We also saw major operations like that in 2013 when COMEX short positions were taken in huge amounts then massive amounts of physical gold [400 tonnes+] was dumped in the physical market. This triggered stop losses and brought another 600+ extra tonnes onto the market from investors reacting to price falls. This sent the physical market plunging nearly a third to hit $1,150. What a profitable operation for the big U.S. banks! Of course the positions can be both ways, where ever the speculators want the price to go.
Since 2013 this has held prices at low levels. During this time China and Russia have been able to acquire huge tonnages for their central banks for and through the Shanghai Gold Exchange.
But it has also served to keep gold prices low and prevent them competing with currencies as an alternative to currencies. Prices north of $2,000 would represent competition to the dollar and other currencies and reflect a loss of confidence in them.
Take the above shape of the market and add all these ingredients together and what do we have?
- Net demand and supply do not affect the gold price that much. Where marginal supply and demand comes to the market their influence should rule prices if the market was isolated to them.
- Speculators in the physical markets can overwhelm this marginal supply and demand. It comes usually from the big banks and their clients who focus on short term profit.
- COMEX paper gold is really froth or surf on the real waves in the market, but somehow this being full of sound and fury is credited with controlling gold prices. This can only happen when major banks and central banks use both London and COMEX to rule prices.
- In the last few years China has taken huge amounts of physical gold to itself and now Shanghai is the global, physical, gold hub. Once it has liberalized its currency and financial markets, we believe it will control the pricing power over gold. It’s inevitable. This will undermine the power of COMEX as physical dealing in both London and New York will see the presence of Chinese demand and supply in its markets. Being far larger than either, the Chinese will overwhelm the western gold market. With the Chinese bank ICBC/Standard a gold market maker in London controlling warehousing for around 3,500 tonnes there, they can buy/sell large amounts to ensure the global price of gold is at levels they want to see!
The absolute proof of the value of gold as money is the fact that central banks continue to be the major holders of gold. It is held as an important reserve asset and acts as a counter to national currencies in reserves.
Only once gold had been sidelined in the U.S. during the 41 years to 1974 could the dollar act as the only currency in the country. Over the generations since 1933, the globe got used to the dollar as the only global money. Eventually, after a considerable campaign against gold from 1975 until 2009 by western central banks and the I.M.F. was gold recognized as a valuable reserve asset. From 1999 until 2009 the Central Bank Gold Agreement stated exactly that.
But the reality is that central banks have never discarded gold as back-up money as is evidenced by the huge tonnages that continue in their reserves.
Indeed, an ex-head of the Bundesbank, Weber, stated that gold is ‘a counter to the gold price’.
Gold is not measured by currency values, gold measures currency values.
We have often written about the dollar succeeded when it became the sole global reserve currency, with the backing of oil [when one could only buy oil using the U.S. Dollar] but that time has begun to wane as a host of nations from European to Russian to Chinese currencies are now chipping away at the dollar’s influence.
De-globalization and Exchange/Capital Controls
Exchange and Capital Controls are often misread as being confined to emergency protection of a currency. They have wider uses and can be used to interfere with specific flows of funds and to control national commercial situations. They include, withholding taxes, duties both imports and exports in specific instances as well as overall financial flows through a country.
They can be extremely effective in boosting a nation’s economy.
Oil and the Dollar
Here is a potential scene that may happen for political as well as economic reasons. A threat is being posed by divisions between Saudi Arabia and the U.S. as the U.S. policy in the Middle East still does not accept that the battle is between Shi’ite and Sunni Muslims not individual nations.
On top of this it is clear that increasing U.S. oil supplies through fracking as well as other sources may well obviate the need for imported oil. As we see Russia and Saudi Arabia appearing to cooperate on freezing or reducing the price of oil, we see not only the price of oil, but the future of fracking lying directly under the control of these two nations. The future will likely see the oil price ‘war’ heat up tremendously to the extent that the U.S. may well want to protect its own oil industry, as well as ensuring it becomes self-sufficient in oil supply. The imposition of duties on imported oil will protect the future profitability of U.S. oil producers [through higher prices] as well as remove the control of U.S. oil prices from outside producers such as Russia and Saudi Arabia. This will also remove the need to guarantee the security of the Persian Gulf.
The boost to inflation through higher prices will also assist in the economic growth levels of the U.S.A.
In turn the lessening of the need for imported [Saudi] oil may well lead Saudi Arabia to accept all currencies for its oil, removing the hold the dollar has had for generations over the oil world.
Once this happens the dollar will remain a leading global currency but lose its role as the sole global reserve currency, while preparing it for its future role in a multi-currency monetary system, whose arrival is inevitable.
The rise of the Middle Kingdom
With the arrival of the Yuan as one of the currencies that make up the Special Drawing Right of the I.M.F. the Yuan has become a global ‘hard’ currency. Its use from now on will accelerate globally, taking from the role the dollar has played until now.
We have no doubt that China will be the largest economy in the world and the wealthiest simply through its population and capabilities. It will be the manufacturer to the world. It will have the financial power to dominate the global economy. Alongside this the Yuan will challenge the dollar to the point that there will be a distinct division of east and west in the global economy.
As an example, imagine China becoming willing to pay Yuan for all imports and demanding Yuan for its exports. Of course, this won’t happen quickly, but gradually so as to minimize any progress in China’s global power.
But at some point there will be international friction in the monetary world. This will lead to currency turmoil and a loss of confidence in most currencies.
Gold in a multi-currency world
Only gold will bring the soothing qualities to the monetary world needed to make it function properly while major changes take place.
As we have written many times before gold will become the fulcrum [or the lubricant] on which the currency world continues to function well. That’s why central banks continue to hold gold in the west and to acquire it in the east!
Looking at the big picture of gold we see the investment/speculative role of gold and the monetary world of gold. As we move to a multi-currency monetary system we see the two sides of the gold world rushing on a headlong path towards a major collision. But, at the moment, they are apart.
Once they collide we will see a rocketing gold price.
At that point nation after nation will see the need for governments to control gold itself and the price just as the U.S. did in 1933. But this time, gold will continue to be dealt freely outside nations that take their citizen’s gold.
At that point nation’s opposition to gold, competing with their currencies, will go the way the U.S. did in the past and harness gold in support of their currencies. But then they will not allow gold to compete against their currencies at institutional or retail levels within their borders. They will ban gold dealing and will appropriate gold within their jurisdictions preventing citizens from holding all but small amounts of gold.
With nations whose currencies are losing the confidence of their trading partners, the use of gold as a back-up asset to repair that confidence will grow. We saw that in the Sovereign Debt crisis in the E.U. gold/currency swaps ‘policed’ by the Bank of International Settlements, which blazed the trail for what we expect to see in the future.
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Julian D.W. Phillips