Why Gold Can Work From Here

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Why Gold Can Work From Here

With all the volatility in global capital markets last week we did not have a chance to update you on the latest data from the World Gold Council. Its quarterly “Gold Demand Trends” report for Q2 2019 showed the following:

#1: Overall gold demand is trending higher this year:

  • Q2 2019 demand up 8% from last year’s second quarter, to 1,123 tons.
  • This is a modest acceleration from Q1’s 7% growth in demand.
  • Important to note: while these numbers look impressive, the first half of 2018 was the slowest period for global gold demand since 2008.

#2: Emerging market central banks (think Russia and China, but others as well) are the key marginal buyers in 2019:

  • Central banks bought 224.4 tons of gold in Q2, up 151% from last year’s second quarter.
  • First half purchases here total 374.1 tons, a 94% increase versus 1H 2018.
  • Important to note: the WGC reports that YTD 2019 central bank buying is “the largest net 1H increase in global gold reserves in our 19-year quarterly data series”.

#3: There are two other notable sources of incremental demand in 2019:

  • “Holdings of gold-backed ETFs grew 67.2 tons in Q2 to a six-year high of 2,548t.”
  • “A strong recovery in India’s jewelry market pushed demand in Q2 up 12% to 168.8t”. That puts this important source of gold demand +2% on the year.
  • Important to note: this shows gold demand is increasing both in financial and physical markets, although the WGC notes that Chinese gold bar/coin demand was down 29% in Q2.
  • Also important: gold supply grew 6% in Q2, led by increased recycling as prices rose.

What we make of all this …:

  • This fundamental analysis shows that it is not just declining/negative interest rates pushing up gold prices just now.
  • Emerging market central bank buying says they may be viewing gold as a structural hedge against increasing global economic uncertainty.
  • In one respect, there’s nothing new about this; central banks have been net gold buyers since 2010.
  • But as the WGC notes 1H 2019 hit records, so clearly central bank demand has found a higher gear.
  • Why? Since gold is priced in dollars around the world, non-US central bank buying is a way for them to have dollar exposure (desirable if your own currency is under pressure) without owning Treasuries or other US-backed financial assets. And, for governments that have an axe to grind to Washington, buying gold is one way to store value without helping the US government fund its $1 trillion/year deficit. In fact, they likely have to sell Treasuries to fund these purchases.

…And what it means for gold prices:

  • Central bank buying seems unlikely to abate any time soon. They see it as a useful hedge, and unlike individual/financial buyers they don’t have to worry about storage and other friction costs. The vaults are built and guarded and the planes to transport the metal sit on the tarmac right now, ready to go.
  • The last marginal gold buyers – individuals buying physical coin/bullion – are not yet in the mix. Data from the US Mint on gold coin sales shows that when this cohort comes on board the gold train (as they did in 2011), the ride is almost over. The latest Mint sales data, which we recently reviewed in our Off The Grid analysis, remains quite soft.

The bottom line: gold is likely heading higher over the remainder of 2019.Remember that central banks are government organizations; they work to a year/multiyear plan. That means they are unlikely to cut back very much on gold purchases in the second half, even with higher prices. If the global economic situation deteriorates further, they may even accelerate their buying. As for the other sources of demand – primarily ETFs – rising prices tend to draw fresh purchases. All this is a decent set-up for further gold price gains.

World Gold Council Q2 report: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q2-2019