The Stalwart Physical Gold Investor

Argentina’s estimated Inflation rate of 26% is also eroding the value of fixed-income securities, causing Argentina’s peso-denominated bonds to lose 5.5% this year versus a 2.2% gain in emerging markets, according to Barclays. Argentines are turning to buying Gold to preserve the value of their savings, as economists forecast the peso will lose more value than any currency in the world and President Cristina Fernandez de Kirchner bans most dollar purchases. Banco de la Ciudad deBuenos Aires, Argentina’s only Gold Trader is talking with mining companies to buy the metal directly as surging demand exhausts its supply of scrap.

The bank began marketing gold to individuals after the nation tightened currency controls in October 2011, selling 280 kilos in its first year for 102.6 million pesos ($20 million), reported Bloomberg. Argentina’s government dollar-denominated bonds fell an average 14.3% since Feb 2011, according to JPMorgan Chase & Co.’s EMBI global index, and the peso weakened 15%. Argentina hasn’t borrowed money from overseas debt markets since its $95 billion default in 2001. With Argentina printing pesos to finance itself, the amount of pesos in the economy has increased 38% in the past year, leading analysts to anticipate that the currency will depreciate 12.9% through year-end. Banco Ciudad is the only bank left that trades Gold after Fernandez banned the purchase of certified 99.99% Pure Gold for savings in July. The boom goes in hand with the inability to buy dollars, and people are looking for alternatives that implicitly hold the value of the dollar.

Gold Demand has been strong for over a year now. Last year, Banco Ciudad limited Gold purchases to 100 grams per person per day in direct sales to individuals. Investors who want to speculate on the Gold Prices without actually owning the metal, are also buying record amounts of Gold Futures contracts. There is a 35% difference between the prices to buy and sell Gold at Banco Ciudad – greater than the gap when trading futures, meaning investors are more at risk of losing money when they need to sell, while there’s no premium to sell the country’s benchmark 2017 dollar bond in the local market. Gold sold by Banco Ciudad also isn’t recognized internationally, making it more difficult to determine its value.

Feeling of “Worst is Over” induces Contradictory Developments in Gold:
In stark contrast, Comex Gold Futures have fallen 11% in the past six months. While Gold Demand is rising in Argentina, Goldman Sachs last month cut its three-month target to $1,615 an ounce from $1,825 while also chopping its 6 and 12 month forecasts. George Soros reduced his stake in the SPDR Gold Trust, the biggest Gold ETF – Exchange-traded fund, by 55% in the fourth quarter of 2012. Several investors are replicating George Soros in liquidating their gold positions, as they feel there are no more requirements for safety in their portfolio. Indian gold funds are shrinking for the first time since June, as investors in the biggest bullion- consuming nation follow Soros in pulling money from products backed by Gold. Gold ETFs saw outflows of 80 million rupees ($1.5 million), data from the Association of Mutual Funds in India show.

Investments in sovereign-debt funds rose by 4.46 billion rupees, the sixth month running for inflows. Gold prices in India have slid 4.3% this year, while rupee bonds returned 2.7%, the second-highest gains in Asia. Although physical demand for Gold accelerates in India from this month onward with the oncoming wedding season, Investments in Indian Gold ETFs are unlikely to recover in coming months as investors will look for appreciating assets. Approximately half of India’s population is younger than 25 years, and with an estimated 15 million weddings expected to take place per year until 2020, the nation is likely to generate demand for an additional 500 tons of gold. MCX Gold June Futures traded on the Multi-Commodity Exchange jumped today to Rs. 30,249 from a dip to Rs. 29,700 earlier. Last month, Goldman Sachs also reversed an assumption that exchange-traded gold holdings will expand in 2013.

Gold ETF Outflows Paint Only Half the Picture:
Since January 1, the holdings of Gold ETFs have dropped by nearly four million ounces (125 tons). February turned out to be the worst month for the world’s largest ETF, the SPDR Gold Trust, which saw its holdings drop to 39.7 million ounces (1,236.73 tons), its lowest level since October 2011. If this were the only data investors looked at, they might conclude that “everyone is selling” and that the bull market is over. But the data are misleading. That’s because while ETF holdings are declining, the physical market is seeing robust support. In fact, the US Mint – the bellwether for measuring demand of physical gold in the Western world, reports that sales of Gold and Silver Coins are soaring, as reported by Casey Metals Team.

The Fickle Gold ETF Investor
Since their introduction, gold-backed ETFs have become very popular, largely because they provide quick and easy exposure to the gold price. Since 2004, “paper gold” vehicles, as bullion ETFs are often called, have accumulated around 2,500 tonnes of gold, thus becoming a major player in the market. As a result, their holdings are closely monitored by investors and analysts. Concerns about falling holdings are thus understandable. But this convenient way to trade gold has attracted lots of different types of investors, including traders, speculators, momentum players, and hedge fund managers who don’t want to bother with storage. Many of these types have little interest in the gold market itself; they are playing fleeting trends and want the quickest and cheapest way to participate. There’s strong reason to believe that the recent selling has come primarily from this category of investor. ETF investors don’t always follow the gold price. While it has been falling since October 2012, Gold investors have demonstrated two opposing behavior patterns. In the final quarter of 2012, holdings grew and even hit an all-time record high of 43 million ounces (Moz) in December, as reported by Casey Metals Team. Since the beginning of this year, however, the fund has been seen massive redemption’s its holdings reaching the lowest level since the fall of 2011. This about-face is another hint that it’s the short-term player and not the big-picture investor dumping shares.

The Stalwart Physical Gold Investor
While ETF holdings have been in decline, the physical Gold Market has seen the opposite trend. 2013 started very strong for the bullion market, particularly coin demand. According to US Mint data, sales of American Eagle Gold coins reached 80,500 ounces in February, up 283% from the 21,000 ounces sold in February last year. In the first two months of this year, the Mint sold 230,500 ounces of the gold bullion coins, 56% more than during the same period of 2012. Silver coin purchases paint an even more dramatic picture. In fact, demand was so great that the Mint suspended sales in mid-January because it ran out of coins. Even with the temporary suspension, January sales of American Eagle Silver Coins spiked to all-time record of 7.5 Moz. February demand was 3.4 Moz, up 126% from last February’s sales of 1.5 Moz. Cumulative silver coin demand for the first two months this year totaled 10.87 Moz, already a full third of total coin sales in 2012.

Keep in mind that bullion purchases from the US Mint account for only part of global physical demand (whereas GLD represents the bulk of gold ETF holdings). Buying of physical gold in Asia continues unabated. For example, during the Spring Festival (held in February) in China this year, sales of investment gold bars increased twofold. Chinese retailers also report that purchases of Gold Coins and Gold Jewelry increased 20-30% over the same period a year ago. Central banks around the world continue making record purchases. Last year, central banks added the most gold to their reserves since 1964 – 17.2 Moz (534.6 tons), 17% more than the previous year, as reported by Casey Metals Team. We’re convinced they will continue to buy gold and remain an important force in the gold market in 2013. The most notable recent purchases were made by South Korea(20 tons or 0.64 Moz), Russia (12.2 tons or 0.39 Moz) and Kazakhstan (1.5 tons or .05 Moz). The point here is that they were buying while ETF holders were selling. North America accounts for less than 10% of the global investment demand for gold, while China and India alone comprise 52%. In the greater scheme of things, what the East does with Gold and Silver will ultimately have a bigger impact on the market.

Gold and Silver Investor Implications:
It’s clear that most gold sales are coming from the “paper” market and not the physical market. Those buying bullion are more inclined to be long-term investors than those buying ETFs. This makes sense; if your main purpose is to preserve wealth through turbulent times, what would you be more inclined to buy – paper, or the real thing? Those who own bullion are also less likely to sell on a whim. Some decision-making went into their buying – locating a reliable vendor, deciding what form of metal to buy, submitting payment, and making arrangements for transfer and storage. That’s a lot of effort to unwind on the basis of a short term fluctuation. While the Hard Assets Alliance program allows one to easily sell metal online, holders of physical gold are less likely to do so during temporary price corrections. ETFs are different in this respect. Since they trade like stock, any investor can quickly enter and leave the market. Some ETF investors may have a long-term investment horizon, but there are clearly those who use the ETF in pursuit of quick returns as reported by Casey Metals Team.

ETF outflows are mainly attributed to hopes for an improving economy.
While it’s too early to say how strong or stable the apparent recovery actually is, we think these investors are overlooking the serious inflation waiting for us on the other side. It’s possible the economy won’t improve at all, and we still get rising inflation.

The core reasons for owning Gold have not changed. Ongoing currency debasement means the long-term prospects for gold are as strong as ever. Any further decline in prices should be viewed as a signal to add another Gold Eagle or Silver Maple Leaf to your stash.