Money / Opinion

Gold’s “Tug of War” (Paper Traders vs. Physical Hoarders) Continues

Michael R. Fuljenz (2)By Mike Fuljenz – 

Imagine a gold bar hanging from a rope being held taut by two strong Tug of War teams. The physical gold buyers – concentrated in Asia, but evident in every national market – are tugging against the fickle sellers of paper gold, mostly via exchange-traded funds (ETFs) and futures contracts in New York City.

Ironically, this Tug of War is being staged between generally rich sellers in rich lands, vs. middle-class private buyers (and central banks) in poor lands.  In particular, central banks in relatively poor lands are buying gold almost every month, while rich sellers are trying to follow the trends of New York’s elite.

If you can imagine this Tug of War containing three strong men on each side, here are their profiles.

Bear #1: Federal Reserve Chairman Ben Bernanke made a surprise announcement on Wednesday, June 19, that he is planning on ending quantitative easing (QE) sooner than expected, by mid-2014.  To date, the Fed has been buying $85 billion per month in Treasury bonds, artificially keeping interest rates low, giving gold an “even playing field” with bonds and cash.  This move caused long-term bond rates to rise rapidly, giving investors a reason (or an excuse) to sell their gold in search of higher returns elsewhere.

Bear #2 is a fan of exchange-traded funds (ETFs). This person follows Warren Buffett or George Soros and is running for the exits. The volume of gold held by ETFs has fallen 20% so far in 2013, from 84.6 million ounces in December to 67.9 million in June. This adds new supply to the market, hurting gold.

Bear #3 trades on the futures commodity exchange (COMEX), where investors can leverage their bets, which can lead to margin calls when gold goes down too fast.  After gold fell sharply in June, Comex (the New York futures exchange) said that it would require investors to put up 25% more collateral, resulting in increased margin calls for leveraged investors, i.e., they must put up more cash or forfeit their position.

The Three Powerful Pullers on the Pro-Gold Side of the Rope

Bull #1 is the Miner: Gold supplies are limited, hard to find and expensive to bring to market.  Costs of production are high and rising.  Currently, the break-even line for underground mines in North America is about $1200 per ounce, near today’s gold price.  Miners will shut down mines that are not profitable. The most easily-mined gold deposits have already been exploited. Many mines are in hard-to-find places with non-cooperative politicians and local activists resisting the presence of any gold exploration efforts there.

Bull #2 is the Saver: Physical demand is rising in most nations, including the U.S. There have been long delays for buying bullion coins in America and elsewhere. The U.S. Mint can’t meet the rising demand for some popular coins. Gold demand is especially strong in the once-poor (emerging) nations of India, China, the Middle East, and parts of South America and Africa.  For the most part, these people want real physical gold (but gold ETFs are now being launched in China, which could be very bullish for gold, too).

Bull #3 is the Central bank community.  In May, Turkey bought 18.2 tons (585,000 Troy ounces) of gold. Russia bought 6.2 tons (198,000 ounces) for its eighth straight monthly purchase.  Kazakhstan also made its eighth straight monthly purchase, this time four tons (127,000 ounces).  Azerbaijan and the Kyrgyz Republic also bought gold in May, while Brunei and Nepal reported gold purchases for April.

The Tug of War continues.  If history is any guide, gold will eventually prevail over paper this time, too.

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7 years ago

The primary case for the rise in gold was that the Federal Reserve was systematically devaluing the dollar through its various QE programs. Debasing the dollar, if those new dollars were actually circulated through the economy, would in turn lead, at some point, to much higher rates of inflation. Excessive inflation by its very nature favors hard assets, such as gold silver, platinum, and oil over paper ones, as a store of value in such times. The problem is the new dollars were NOT circulated through the economy. That money sat on deposit at the Fed earning interest for the… Read more »

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