Gold Price Mystery Solved?

There’s been a lot of speculation lately as to why the price of gold hasn’t gone up substantially despite reports coming in from all over the country about a new “gold rush.” MarketWatch’s Morning Zhou may have helped shed a little light on the mystery this morning when she wrote:

Retail investors sharply increased their demand for gold bars and coins in the past few months as they struggled to find a safe place for their money amid the financial crisis, research shows.

But institutional investors have kept the upper hand, according to Wednesday’s report from the World Gold Council, a gold mining industry association. Heavy selling by institutions has more than offset retail buying and pushed gold prices to their lowest level in more than a year.

Zhou said that demand from retail investors for the yellow metal, especially in its physical form, has been nothing short of phenomenal. From the MarketWatch piece:

Moves by retail investors, including demand for bars and coins, resulted in a net inflow of 232 tons (7.46 million ounces) in the third quarter, compared to 105 tons in the same time frame a year ago.

The figures, compiled independently for the council by GFMS Ltd, a precious metals consultancy, show strong bar and coin buying in Swiss, German and U.S. markets.

Meanwhile, gold holdings in exchange-traded funds rose 150 tons, compared with an increase of 4 tons in the second quarter and 139.5 tons in the third quarter a year ago. The peak in ETF inflows occurred in late September after the collapse of Lehman Brothers.

Much of that money added to the gold holdings in the SPDR Gold Trust (GLD ), the largest gold ETF, to more than 770 tons in October, a cache that exceeds the official holdings of Japan, which has the world’s seventh-biggest gold reserves.

Demand for physical gold didn’t slow even when some financial institutions were forced to sell their gold assets to ease the squeeze in their cash balances…

Including industrial and dental use, physical gold demand in dollar value hit an all-time high of $31.8 billion in the third quarter, the WGC reported. In tonnage terms, it stood at 647.6 tons, the highest since the second quarter of 2007.

However, when one examines recent institutional selling of the precious metal, the mystery of a depressed gold price begins to unravel. Zhou wrote:

On the other side of the tussle, some institution investors sharply reduced their gold holdings for much-needed cash in the face of the credit crunch.

Institution investment saw a net outflow of nearly 300 tons in the third quarter, according to the WGC, which more than offset the inflows in the retail sector.

Big institutions trade with each other directly in large orders through the opaque over-the-counter markets. They also bet on futures exchanges in New York, Tokyo and a few other places.

Gold was “one of the few assets remaining that could be sold at a reasonable price to meet margin calls on other, worse-performing assets,” the WGC said in the report.

The significant outflow in the institutional level explains why the gold price did not perform better in the face of strong jewelry buying and demand for physical gold, the WGC said in the report.

Mystery solved?

Source:

“For gold, a tussle between two groups of investors”
Morning Zhou
MarketWatch, November 19, 2008

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Mammoth Says:
November 20th, 2008 at 2:15 pm

Thanks for the informative post, Chris. This seems a feasible explanation, and helps dispense away with the conspiracy theorys about govt. manipulation of the Gold price.

So, the question remains - has the majority of the institutional selling, in order to raise cash in the face of redemptions and the credit crunch, ended? If so, then the price of gold may stabilize or begin creeping upwards.

But if more institutional selling is coming, then the bottom for Gold may still be ahead of us.

-Mammoth

Gold and Silver Blog Says:
November 20th, 2008 at 3:33 pm

There are a number of factors at play, but yes it definitely seems like these are two of the most significant. This situation would also lend some explanation to the high premiums for physical gold. Surplus of paper gold from the institutional selling, scarcity of physical gold from the retail level buying.

Editor Says:
November 21st, 2008 at 7:28 am

Thanks for the comment Mammoth.

“… helps dispense away with the conspiracy theorys about govt. manipulation of the Gold price.”

Oh, I don’t know. There still may be some truth to this. After all, governments and central banks have every incentive to keep the gold price down in a global financial system where confidence in fiat currencies must be maintained— at all costs.

“So, the question remains - has the majority of the institutional selling, in order to raise cash in the face of redemptions and the credit crunch, ended?”

You might want to note the following comments from the same MarketWatch piece:

“Funds who would like to keep their asset of last resort are being forced to sell,” said Peter Spina, an analyst at GoldSeek.com. “This is causing weakness in the paper gold market price, but it is not a true reflection of the physical market.”

“There will be more victims of the fund collapse and more forced liquidations even if it requires selling your most desired assets such as precious metals,” he added. “Once this process works itself through, the true market prices for gold will readjust.”

Also:

Some analysts said gold prices would rebound soon as much of the selling that occurred among institutions had a short term focus, and did not reflect a decline in gold’s fundamentals.

“In the gold market, the moment the weight of forced selling stops, the demand-supply balance will take precious metals higher and quickly,” said Julian Phillips, an analyst at GoldForecaster.com.

We’ll see what happens…

Editor Says:
November 21st, 2008 at 7:44 am

Thanks for the comment Gold and Silver Blog.

“There are a number of factors at play, but yes it definitely seems like these are two of the most significant.”

Agreed. Not a “tell all” post, to be sure.