Gold – Still Widely Hated

Bearish Sentiment and Depository Flows

Whether it is Goldman Sachs, Morgan Stanley, or lesser known 'metal consultancies', there is unanimity among analysts about gold: it will go lower. Four days before gold briefly regained the $1,300 level, Morgan Stanley was certain it would “not see the $1,300 level again in 2014”. Some of the arguments make at least superficial sense, e.g. Goldman expects a stronger US economy (the famed 'second half' recovery is on its way once again), while Morgan Stanley is still waiting for a 'stronger dollar and rising interest rates' since January (neither has obviously occurred, but these would be headwinds for gold if they were to happen).

The aforementioned metal consultancy mentions among other things a “21.8 tonne structural deficit in the market last year” as well as ETF outflows, both of which represent not even rounding errors in gold's overall supply-demand picture. We cannot be sure what the total global gold supply amounts to precisely, but given new mine production of about 2,500 tons p.a., the supply increases by about 1.4% every year and may by now well amount to between 175,000 to 180,000 tons. In what way a '21.8 ton structural deficit' could have mattered last year is therefore a mystery.

The same goes for ETF outflows, which similar to central bank buying hardly matter to gold's price. ETF flows are aneffect, not a cause of gold's price movements – mainly they depend on the intra-day price moves in GLD relative to spot gold.

Authorized participants in GLD tend to buy physical gold and create shares when the ETF trades at a premium to spot, and tend to do the opposite when it trades at a discount (provided the premium/discount is large enough to make the transaction worthwhile. With short term interest rates close to zero, these premiums and discounts don't need to be very large). Thus, GLD and similar open-ended ETFs are  reflecting short term sentiment on gold, but they are certainly not price drivers. One only needs to look at SLV's holdings: silver has declined even more sharply than gold, but SLV's holdings have remained stable and even risen slightly during a considerable part of the price decline.

It becomes even more glaring if one looks at all known depositories of gold and silver the holdings of which can be tracked. Silver depositories that publish their holdings hold now more metal than ever before, while the amount held in gold depositories that can be tracked (including exchange warehouses, mints and ETFs) have sharply declined. And yet, the prices of both metals have moved in the same direction and gold has actually been a lot stronger than silver.

To this it must be remembered that when gold and silver disappear from such depositories, they don't disappear from the face of the earth. All it means is that they are now held in places that are not publishing figures we can observe.

SLV's holdings contradict the theory that amounts added or subtracted from large depositories that publish their holdings have any influence on precious metals prices – click to enlarge.

GLD price and holdings of gold bullion – click to enlarge.

Silver, combined holdings of all depositories that can be tracked – click to enlarge.

Gold, combined holdings of all depositories that can be tracked – click to enlarge.

For a useful summary of how the gold price is actually formed, we refer you to Robert Blumen's article  “What Determines the Price of Gold?”.

Some Additional Anecdotal Sentiment Evidence

Gold certainly hasn't done much of late – at the moment, it is stuck right in the middle of this year's range. However, it must be remembered that the banks that are now unanimously bearish (see their forecasts from January here), were just as unanimously bullish back when gold was trading in the $1,600-$1,800 area, and also 'didn't do much'. In other words, they will always miss the turning points and only change their views after a large price movement has already occurred. The only valuable insight that can be gleaned from their consensus is that it is probably wrong.

Their forecasts depend on the correct prediction of trends in ancillary macro-economic data, i.e., the things that actually do matter to the gold price. Among these are: credit spreads, the steepness of the yield curve, inflation expectations and real interest rates, the dollar's trend, society's propensity to save, money supply growth (andexpected money supply growth), government debt growth, and not least, faith in the monetary authorities.

Only if their forecasts are correct about the future trends in these data will they likely also correctly forecast what the gold price is going to do. So the question is, how likely is that? Not very, would be our guess.

Gold, June contract, daily – still stuck in the middle of this year's range – click to enlarge.

Lately additional anecdotal evidence has emerged. Our good friend Ronald Stoeferle of the Incrementum Fund in Liechtenstein (who writes Erste Bank's famous 'In Gold We Trust' reports) has just returned from the Denver Gold Group's European Gold Forum conference in Zurich. Here are a few of his sentiment related observations (paraphrasing):

1. There was very little attendance. Mostly mining executives, promotion guys etc., but only very few investors and media reps.

2. The few investors who attended were very desperate due to suffering losses ranging from 40 to 70% last year.

3. James Turk delivered an excellent speech. A few years ago, when James presented, the room was packed and people were sitting on the floor. This time the room was almost empty.

Here is a photograph that documents how small the crowd attracted by James Turk was on this occasion:

James Turk in Zurich – many empty chairs – this time certainly no-one had to sit on the floor.

(Photo source unknown)

Although Ronald wasn't overly impressed by many of the managers of mining companies, he noted that “it seems that the mainstream world has completely lost interest in this sector. Therefore I believe that it is the most contrarian play at the moment”.

Conclusion:

Although none of this tells us anything about the next few days or weeks, it confirms what could be observed in quantitative sentiment and positioning data over recent months. The only other market sector that seems to have experienced a similar loss of investor interest is the coal sector.