Placeholder Gold vs Physical Gold – Spot The Massive Disparity

In his latest edition of Things That Make You Go Hmm (subscription is highly recommended), Grant Williams explains how he has been watching several gold market trends unfolding throughout this past year. Many of the figures do not add up, he explains. Despite clear evidence of massive demand for physical gold, “The Gold Price” has continued to trade poorly.

However, the longer this situation persists, the more definitely it will resolve itself; and it’s very hard to see how that resolution ends in anything but higher prices.

Demand levels from Asia continue to soar while production increases just a couple of percent each year; and leaving aside Indian festivals and increasing central bank purchases, the fiat alternative to gold bullion — the US dollar — is coming under renewed pressure in the wake of the Taper That Never Was and the appointment of Janet Yellen as Ben Bernanke’s successor.

The following is an excerpt from Grant Williams his latest report, in particular his analysis on the gold market: East vs West, physical gold vs “placeholder” gold. 

Westerners aren’t used to the kind of inflation levels, government confiscation, and currency volatility so common in places like India; and so the need to own gold as protection isn’t fully appreciated in the West.

Westerners pay lip service to gold’s being “an inflation hedge” or “a currency” or “a safe asset”, but these terms are used in an extremely abstract way by the vast majority of the investing public, who see gold as mostly just another trading vehicle. Yes, there are Western investors who have a deeper understanding of the reasons for owning physical gold, but they are a tiny minority.

Perhaps the simplest way to illustrate this point is to look at trading volumes in gold ETFs — a simple, effective way of renting gold for the short term for punters investors — to see how Western and Eastern volumes compare.

For the purposes of this exercise, there’s nowhere better to go than the heavyweight champion of the gold ETF world, GLD:


Source: Bloomberg

As you can see from this chart, the average daily turnover of GLD on the NYSE is a little shy of 11 million shares. At current prices, that is roughly US$1,419,127,163 or $1.4 billion. Every day.

Fortunately, the GLD ETF is also listed on the Tokyo, Hong Kong, and Singapore stock exchanges; so a comparison is extremely straightforward.

What do the volumes in Asian trading of paper shares offering “ownership” of gold custodied in the London vault of HSBC look like?

Well, they look like this:


Source: Bloomberg

Now, eagle-eyed readers will have noticed that I didn’t include the average lines for the three Asian exchanges. The reason for that is simple: they are so close to the X axis as to be almost invisible.

To provide a clear picture of the contrast between GLD volumes on the Western and Eastern exchanges, what I will do instead is show the average daily turnover on all four exchanges as dollar figures on the same chart (below).

I actually had to delete the line that demarcated the X axis, because, with a 1pt stroke on it in Adobe Illustrator, it became too difficult to see the bars for Japan, Hong Kong, and Singapore; so the chart looks a little strange.

What’s that? The Asian exchange volumes are a little difficult to make out? Ah… well, in that case, let me clarify it for you:

The volume on the NYSE is approximately 700x that of both Tokyo and Hong Kong and a mere 350x that of Singapore.

In short, Asians like their gold to be heavy, shiny, and made of … well, gold.


Source: Bloomberg

This massive disparity in appetite for “placeholder gold” is just one side of the coin, however; and India is just one of the Eastern countries that has been soaking up copious amounts of physical gold in recent months.

Why? Well, I’ll hand it back to S. again, as he finishes his article with something of a flourish:

The economic establishment wails that gold does not obey its policies. Gold defies government policies because of the disconnect between the policies and the people. Indians revere, not simply love, gold. But the State policies are founded on the economic theories of the West which treat gold like any other commodity for trade and profit. It is no surprise that the theories, which work in the West but not here, project gold as India’s villain.

Yet, gold has emerged as the winner in economics — successfully hedging inflation and beating the stocks and banks. With the unalterable basic facts about gold in India known, the real challenge is how to frame a practical and workable policy for gold and how to ensure that gold imports do not affect the macro economy. Gold buying by Indians is seen as weakening India. But buying is economic power as well — in fact, the ultimate economic power is a nation’s market. Yet, surprisingly, India has not put to use its enormous power as one quarter of the world’s retail market for gold. India has to strategise and use its huge market to overcome the weakness of its people for gold. How to do it is the challenge and a topic by itself.

Indeed. How do you get the gold out of Indian citizens’ hands and into government coffers? I can think of one way, but I wouldn’t advocate trying it.

The evidence of physical gold’s being sucked ever more violently from West to East grew hugely this past week when figures were released for gold exports to Switzerland through London:

(Reuters): A surge in gold exports from the United Kingdom to Switzerland this year may largely be the result of metal sold out of exchange-traded funds being shipped for re-refining before making its way to Asia, according to Australian bank Macquarie.

UK gold exports to Switzerland, Europe’s major bullion refining hub, jumped to 1,016.3 tonnes in the first eight months of this year, data from European Union statistics agency Eurostat shows, from 85.1 tonnes in the same period of 2012…. A surge in gold exports from the United Kingdom to Switzerland this year may largely be the result of metal sold out of exchange-traded funds being shipped for re-refining before making its way to Asia, according to Australian bank Macquarie.

UK gold exports to Switzerland, Europe’s major bullion refining hub, jumped to 1,016.3 tonnes in the first eight months of this year, data from European Union statistics agency Eurostat shows, from 85.1 tonnes in the same period of 2012…. Asia is by far the world’s largest centre for physical gold demand, with China and India between them responsible for nearly half of global gold fabrication demand, which includes jewellery manufacture.

Buying in Asia shot higher in the second quarter of the year after a sharp drop in gold prices, which spurred consumer demand.

“Given the outflows from ETPs, strong demand in Asia and refining capacity in Switzerland, it is possible the metal is headed for Asia through Switzerland,” Barclays Capital analyst Suki Cooper said.

That is a twelve-fold increase in bullion traffic between the primary vault in London and the major refineries in Switzerland.


Now, we don’t know with absolute certainty where that gold is ultimately bound — but we know it isn’t Switzerland. If we throw into the mix the widely covered movement of gold into China through HK, a picture begins to emerge of an incredible wave of physical metal heading from West to East, even as the price continues to languish.

One of the primary sources of supply in this steady transfer of physical bullion has been the GLD warehouse. I’ve touched on the subject of the incredible vanishing ETF gold holdings before, but it’s worth revisiting the phenomenon and reminding readers of a chart I included in the July 16th edition of Things That Make You Go Hmmm…, entitled “What If?“:


Source: TTMYGH/Bloomberg/COT

This chart shows the precipitous drop-off in both ETF holdings and gold stored in the COMEX warehouses.

The gold in London is heading somewhere — and it’s heading there via Switzerland, by the looks of it.

Taking that chart a step further, we find yet more evidence of a major disconnect between the two biggest precious metals ETFs, GLD and SLV. As you can see from the first chart below, the prices of both “monetary metal” ETFs have performed pretty badly so far this calendar year, with GLD falling a chunky 20%:


 Source: Bloomberg

The extent of this decline is cited by mainstream commentators as the reason for the hollowing out of the amount of metal held in custody on behalf of the GLD ETF. The silver ETF has fared even more poorly, with its customary volatility pushing it 27.5% lower year-to-date.

Tough times to be a precious metals bull, to be sure.

Now, however, take a look at the total reported physical metal holdings of all precious metals ETFs. (These figures extend wider than simply GLD and SLV and take into account all the major competing products.)


Source: Bloomberg

Notice anything?

Yes… holdings of silver in ETFs have actually increased as the price has fallen nearly 30%, while gold bullion in custody has plummeted.

Now, if there’s anybody out there who can explain this phenomenon to me, I am genuinely interested in hearing any and all plausible explanations.

I said “plausible”, folks.

This draining of physical metal was always going to cause stresses somewhere in the machinery at some point — it was only a matter of time — and the Indian central bank’s “war on gold” seems to have been the final straw.

As the RBI’s working group so neatly summarized on page 9 of their 224-page paper: “Demand for gold is not strictly amenable to policy changes and also is price inelastic due to varied reasons.”

Of course, despite the fact that gold isn’t “strictly amenable to policy changes,” nor does it have any price elasticity, the Indian government went ahead and made a raft of policy changes designed to curb gold buying. The upshot?

(Bloomberg): Gold premiums in India, the world’s largest user, climbed to a record as jewelers rushed to secure supplies to meet soaring demand during festivals and weddings amid government curbs on imports.

The fees paid by jewelers to banks and other importers climbed to as much as $120 an ounce over the London price this week compared with a discount of $60 a month earlier, said Bachhraj Bamalwa, a director at the All India Gems & Jewellery Trade Federation. Premiums may surge to $150 to $200 if the shortage persists, he said.

The raw material scarcity is worsening as imports slumped after the government linked shipments to re-exports in July and increased tax on overseas purchases for a third time this year to curtail demand. Purchases of gold and silver tumbled to $800 million last month from $4.6 billion a year earlier, the Commerce Ministry said Oct. 9.

“There is a shortage in the market and there will be panic in the market with each passing day” if supplies don’t increase, Bamalwa said. “The government is comfortable because import of gold is reduced but it’s a problem for consumers. Gold is in our culture and we can’t change that.”

Those final ten words are the key.

There now exists something of a perfect storm in the physical gold market as we move deeper into the Indian festival season.

Demand at this time of the year in the subcontinent is “inelastic” (as the geniuses at the RBI eventually surmised). The GLD ETF has already lost nearly 35% of its bullion this year; China has been hoovering up as much physical gold as it possibly can (through Hong Kong and, most likely, Switzerland); and we are now set to move into what has been, for the last 40 years, the strongest part of the year with regard to the price performance of gold (driven largely by that Indian festival season).

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