Now Is the Time to Buy Gold
By Bud Conrad of Casey Research
Gold has been in a downturn for more than two years now, resulting in the lowest investor sentiment in a long while. Hardcore goldbugs find no explanation in the big-picture financial numbers of government deficits and money creation, which should be supportive to gold. I have an explanation for why gold has been down – and why that is about to reverse itself. I’m convinced that now is the best time to invest in gold again.
Gold Is the Alternative to Non-Convertible Paper Money
If you’ve been a Casey reader for any length of time, you know why gold is a good long-term investment: central banks are expanding paper money to accommodate the deficits of profligate governments – but they can’t print gold. Since the beginning of the credit crisis, the world’s central banks have “invented” $10 trillion worth of new currency notes. They are buying up government debt to drive interest rates down, and therefore to keep countries afloat. The best they can do is buy time, however, because creating even more debt does not solve a credit crisis.
COMEX and GLD ETF Inventories Are Down from the Demand
The COMEX futures market warehouses dropped 4 million ounces (over 100 metric tons) in 2013. The COMEX uses two classes of inventories: the narrower is called “registered” and is available for delivery on the exchange. There are other inventories that are not available for trading but are called “eligible.” I don’t think it’s as easy to get holders of eligible gold to allow for its conversion to registered to meet delivery as the name implies. Yes, that might occur, but only with a big jump in the price.
The chart below shows the record-low supply of registered COMEX gold.
(Click to enlarge)
Meanwhile, SPDR Gold Shares (GLD), the largest gold ETF, lost over 800 metric tons of gold to redemptions. At the same time, central banks have provided gold through leasing programs (but figures are not made public).
Why Has Gold Fallen $700 Since 2011?
In our distorted world of debt-ridden governments and demand from Asia, gold should continue rising. What’s going on?
The gold price quoted all day long comes from the futures exchanges. These exchanges provide leverage, so modest amounts can be used to make big profits. Big players can move markets – and the biggest player by far is JPMorgan Chase (JPM).
For the first 11 months of 2013, JPM and its customers delivered 60% of all gold to the COMEX futures market exchange; that, surely, is a dominant position that could affect the market. By supplying so much gold, they are able to keep the price lower than it would otherwise be.
A key question is why a big bank would take positions that could drive gold lower. Answer: Banks gain by borrowing at zero rates. But the Federal Reserve can only continue its large quantitative easing programs that bring rates to zero if gold is not soaring, which would indicate weakness in the dollar and the need to tighten monetary policy. Voilà, we have a motive. Also, suppressing the price of gold supports the dollar as a reserve currency.
The chart below shows the month-by-month number of contracts that were either provided to the exchange or taken from the exchange by JPM. For a single firm, the numbers are large, but the effect across all gold markets is greater because so many gold transactions follow the price set in the paper futures market.
(Click to enlarge)
What jumps out from the chart above is the fact that while JPM had been selling gold into the futures market for most of the year, it made a major shift in December, absorbing 96% of all gold delivered.
That is a radical shift and, I believe, an indicator that JPM’s policy has changed. In my opinion, their deliveries of gold were suppressing the price during 2013, but now their policy has reversed in a way that will support gold going forward.
This leaves a vital question: Why?
Has the motivation to suppress the price of gold gone away? Not likely, and we may never know the full truth of what is happening, but I suspect the main reason for the shift is that they have done their damage. The $740 drop from top to bottom, a 39% decline, has shaken confidence in gold as a financial “safe haven” among many investors, especially those new to precious metals.
At the same time, continuing to lean on gold at this point could become very costly. JPM delivered $3 billion (about 2 million ounces of gold) into the market up to December in 2013, and may not have ready sources of gold to keep that up. It is dangerous to put on big short positions unless you have gold or some future gold deliveries as a hedge.
By now, everyone knows of the shortages in the gold market; JPM has to be as aware of that as the rest of us. It just isn’t safe for them to continue to lean on the market. Being aware, it looks like they are taking the bet that gold will rebound, so they could do well on the other side of the trade.
Another confirmation of the shift by big banks comes from data provided by the US Commodity Futures Trading Commission (CFTC) that shows the net positions of the four biggest US banks in the futures market. There has been a dramatic change from being short the market to now being long.
(Click to enlarge)
Crisis Brewing in the Gold Market
JPMorgan’s COMEX warehouse contained 3.0 million ounces of gold in 2012, but that had dropped to 0.5 million ounces by mid-2013. Its registered inventories are a razor-thin 87,000 ounces. These kinds of swings are indicative of shortages and instability.
Further, JPMorgan sold its gold vault in New York City – located next to the Federal Reserve’s vault – to the Chinese. The banking giant also just announced the sale of its commodities trading business (although it may not have sold the precious metals part of that business). Perhaps they are concerned about new regulations of banks with deposit insurance from the government.
In another relevant development, Deutsche Bank recently surprised the gold community by quitting its position on the committee that sets the London A.M. and P.M. fix. This came a few weeks after a German regulatory body called BaFin started investigating how these prices were set. BaFin also gave an indication that the process appeared worse than the LIBOR fixing scandal, which resulted in billions in fines.
Putting Inventories and Traders Together
The futures market looks fragile to me. The basic problem is that there are many more transactions that could put a claim on gold than there is gold registered for delivery in the COMEX warehouses.
The chart below gives a dramatic picture by simply dividing the open interest of all futures contracts by the registered inventories. The black line at the bottom shows the big jump in the ratio as the registered inventories declined. There are 107 times more open-interest positions than there is registered gold.
(Click to enlarge)
Gold Will Rise, and It’s on Sale Now
Now is the time to stake your claim in gold. In the long term, we know that paper money will become worthless; in the short term, the biggest seller has just shifted its stance to becoming a buyer. That makes this a good time to accumulate gold before a major shift upward in price.