Is Demand For Physical Gold Declining?

Demand for physical gold is allegedly collapsing. Is that true and what would it mean for the gold market?

Physical Demand Doesn’t Drive Gold Prices

Simon Black from sovereignman.com has recently reported the significant decline in sales of physical bullions. For example, sales of U.S. Eagle gold coins fell by 67 percent in February, on an annual basis. And, as we have already reported, the jewelry demand had a tough time in 2016. Meanwhile, the price of gold went up, which clearly shows that physical demand does not drive gold prices. The opposite is true: retail investors are highly sensitive to the price, so they reduced their purchases because of higher prices.

Paper vs. Physical Gold

According to the author, that divergence results from the huge difference between physical gold and paper gold. Surely, there is a distinction between owning bullion and gold ETF-s or gold futures. However, we do not agree that these contracts are “merely financial instruments to gamble on the paper price of gold”. We could say that they are useful financial instruments which enable investors and traders to get exposure to the price of gold (with less capital at hand), while not owning physical metal and not worrying about its storage. Again, it is true that paper gold has counterparty risk, but unless there is a total financial apocalypse, we may assume that such risk is not very grave (we refer here to gold futures).

You see, the price of gold, as we explained in one of the previous editions of the Market Overview, is set in New York and London. The price of physical bullion is derived from paper prices, and “bullion dealers usually quote prices higher than [the international paper price], since they bear higher costs than wholesale players and add some markup to make a profit”. Hence, even if you purchase bars or coins, you do not insulate yourself from the paper market – in the physical market, you just pay a premium for owning the shiny metal. We do not say that it is a bad idea, especially if you believe in the imminent collapse of the dollar and the global financial system, but we do not perceive paper gold as something evil or – to use the currently popular term – fake. On the contrary, the development of gold futures and ETF-s democratized the market, enabling many retail investors to gain exposure to gold prices. And eventually – isn’t that the whole point of owning gold? What is the use of gold bars or coins, if you cannot sell them smoothly for a decent price?

There Is No Gold Shortage

Another myth about the gold market is the shortage of gold (it’s really amusing that we can see articles on both gold shortage and declining demand at the same time – and all of them argue for you to buy gold, of course). Oh, for Christ’s sake, we have seen so many articles which proclaim “peak gold” and call for $2,000 per ounce. Some analysts have argued for years that gold prices have to skyrocket, because new gold discoveries are fewer and there is worldwide gold shortage. All these claims turned out to be false. The reason is simple: gold should not be analyzed as commodity, but as currency. Why? Well, nearly all bullion in the world that has ever been produced is still held in some form. Therefore, mining is negligible compared to the overall supply, adding only about 1 percent to it each year. In other words, the supply of gold does not depend on the new gold discoveries, but on the free decision of the holders of gold who decide to bring it into the market. We do not argue that gold prices will not go up in the long-term, but definitely not because of gold shortage. There is a shortage – but not of the yellow metal, but of sensible and fair analyses.

Disclaimer: Please note that the aim of the above analysis is to discuss the likely long-term impact of the featured phenomenon on the price of gold and this analysis does not indicate (nor does it aim to do so) whether gold is likely to move higher or lower in the short- or medium term. In order to determine the latter, many additional factors need to be considered (i.e. sentiment, chart patterns, cycles, indicators, ratios, self-similar patterns and more) and we are taking them into account (and discussing the short- and medium-term outlook) in our trading alerts.