Gold Versus Oil Versus Copper

Let’s take a look at gold. It hasn’t responded to US$85 billion per month of QE (which launched in December 2012)…it hasn’t responded to the US government shutdown and it hasn’t responded to the threat of a technical US default.

So what is its problem? We know demand remains robust on the physical side of things. China’s net imports so far this year are well over 730 tonnes. That’s well in excess of the 450 tonnes released by GLD, the world’s largest ETF, selling which the media seems to wring their hands about when it comes to gold demand.

No, the problem is on the paper (not physical) side of the market. By paper we mean gold derivatives. The supply of gold derivatives is much larger than the supply of physical metal, which means the derivatives market sets the price.

This supply, which has grown over the years, has effectively commoditised the gold market, turning a ‘precious’ monetary metal that is never consumed into a regular, every day, industrial metal.

Here’s what we mean by that. Yesterday, we produced the chart below for subscribers of our publication, Sound Money. Sound Investments. It shows the performance of gold (black line) and copper (red line) since the start of the commodity bull market back in 2000.

click to enlarge

After nearly 14 years, the performance of the industrial metal versus the precious metal has been exactly the same.

And it’s the same with gold versus oil, as the chart below shows. Oil is the black line. Again, after 14 years the performance of the two has been exactly the same.

click to enlarge

So if you’re wondering why gold isn’t performing as you think it should (as a precious metal) that’s because it’s a commodity. It’s a plaything of the paper traders. If oil or copper or silver sell off on economic concerns, gold sells off too. They don’t always move in lock-step, but if they’re at the same spot after 14 years, you have to acknowledge that they gravitate around one another.

Here’s a question for you then…

What would happen if the global economy continues to sink under the weight of debt and QE, pushing demand for commodities, and thus commodity prices, lower? Gold would continue to fall, right?

And if the gold ‘price’ continues falling, wouldn’t that just increase the demand for physical gold from the ‘East’ as has happened in a major way since the ‘price’ plunge earlier this year?

Our guess is that it probably would. This has important consequences for the ‘gold as a commodity’ trade. Before we get to that, consider the following…

China’s holdings of US Treasuries peaked in mid-2011. Over the past two years it has reduced its holdings by around US$40 billion. Throw in annual interest of around US$30-40 billion (depending on the average interest rate) and there’s a lot of money flowing elsewhere.

No one knows where it’s going, but consider that China’s gold imports really began to pick up in 2011. Net imports from Hong Kong (the only publically available data on Chinese gold demand) came in at 380 tonnes for the year, up from 115 tonnes in 2010. In 2012, net imports jumped to just over 570 tonnes and for the year to August 2013, net imports are already around 735 tonnes of gold.

Let us spell it out:

2010:                           115 tonnes
2011:                           380 tonnes
2012:                           570 tonnes
2013 (so far):                735 tonnes

From roughly around the time the gold price peaked, China has ramped up its demand for physical. Yet this has had no impact on the price…yet.

We say ‘yet’ because it inevitably will. The derivatives market, which is the market that sets the gold price, needs a base of physical gold to operate on top of. The paper price ‘derives’ its value from this underlying physical base. That’s because Western paper traders need to know that something real underpins the market they are playing in. It gives the game some slender form of credibility.

But we also know that physical gold is flowing out of the Western financial system (London and New York) and heading eastwards. If this eastward flow continues – and we expect it to pick up as the ‘price’ continues to fall – then there will be no base from which the paper gold market can operate.

At that point, gold will no longer be ‘commoditised’ by the derivatives market and it will break away from copper, oil and all other industrial commodities.

Of course we don’t know when it will happen, or how it might look. But US political idiocy, ongoing QE to fix non-existent cyclical problems, and foreigners turning their backs on the Treasury market will all speed up the process.

Tomorrow we’ll explain why gold is not a commodity, and why it should not trade like one…


Greg Canavan+
for Markets and Money

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Greg Canavan is a Contributing Editor at Markets & Money and Head of Research at Port Phillip Publishing. He advocates a counter-intuitive investment philosophy based on the old adage that ‘ignorance is bliss’. Greg says that investing in the ‘Information Age’ means you now have all the information you need. But is it really useful? Much of it is noise, and serves to confuse rather than inform investors. And, through the process of confirmation bias, you tend to sift the information that you agree with. As a result, you reinforce your biases. This gives you the impression that you know what is going on. But really, you don’t know. No one does. The world is far too complex to understand. When you accept this, your newfound ignorance becomes a formidable investment weapon. That’s because you’re not a slave to your emotions and biases. Greg puts this philosophy into action as the Editor of Crisis & Opportunity. He sees opportunities in crises. To find the opportunities, he uses a process called the ‘Fusion Method’, which combines charting analysis with more conventional valuation analysis. Charting is important because it contains no opinions or emotions. Combine that with traditional stock analysis, and you have a robust stock selection strategy. With Greg’s help, you can implement a long-term wealth-building strategy into your financial planning, be better prepared for the financial challenges ahead, and stop making the same mistakes that most private investors do every time they buy a stock. To find out more about Greg’s investing style and his financial worldview, take out a free subscription to Markets & Money here. And to discover more about Greg’s ‘ignorance is bliss’ investment strategy and the Fusion Method of investing, take out a 30-day trial to his value investing service Crisis & Opportunity here. Official websites and financial e-letters Greg writes for:


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