Friday , 21 October 2016

We Could Be On The Verge Of A Perfect Storm For Gold – Here’s Why

There are a lot of reasons to consider owning gold today – a topsy-turvy stock market, the threat ofgold rising deflation and/or recession, and negative interest rates in many parts of the world. These are some of the reasons gold has posted such a strong start to the year but there’s another potential driver for gold that most investors have overlooked – or are completely unaware of – that could light a fire under the yellow metal’s price. It’s a matter of how much money is available to buy gold, compared to how small the gold industry is.

This post is an enhanced version (i.e. not a duplicate) of the original by Tim Smith ( as it has been edited ([ ]) and abridged (…) by to provide a faster and easier read. Enjoy!

It really is a David and Goliath thing…

Just How Tiny Is The Gold Market?
It’s smaller than many investors realize. Here’s a comparison of the last year’s annual supply of gold (i.e., the amount of gold supply for one year from production, scrap, etc.) and the market cap of some well-known stocks. The figures below are based on gold selling at an average of $1,200 per [troy] ounce.

Fig. #1
Market Cap of Popular Stocks vs. The Gold Supply (as of 04/01/16)

Source: Yahoo! Finance.

 Coca-Cola’s market cap is bigger than the value of all of last year’s gold supply. Apple Computer is roughly three times larger. Disney shareholders alone could buy an entire year’s worth of gold supply. The point is that it wouldn’t take much money from institutional investors entering this sector to disrupt the market and send prices higher and here’s one source of funds that few investors are watching…

The Elephant In The Room: Pension Funds
It’s fair to say that the fund management industry handles the bulk of the world’s wealth. These are institutions like hedge funds, insurance companies, mutual funds and sovereign wealth funds but the granddaddy of them all is pension funds. These are both public and private organizations that provide retirement income.

Global pension assets were estimated to be – drum roll, please – $35.4 trillion at the end of 2015, the most recent data available. No, that is not a misprint. It is almost twice the size of the U.S.’s 2015 gross domestic product ($17.9 trillion).

According to estimates from his book Hard Money; Taking Gold to a Higher Investment Level, Shayne McGuire, head of global research at the Teacher Retirement System of Texas, says the typical pension fund holds about 0.15% of its assets in gold. He estimates another 0.15% is devoted to gold mining stocks, giving us a total of 0.30%….[are] invested in the gold sector…

Here’s what that portion looks like:

Fig. #2
Portion of Gold Holdings In a Typical Pension Fund

Source: Shayne McGuire.
Gold is, by any account, a negligible portion of a fund’s asset allocation. Now, here’s where it gets interesting.

…If pension fund managers decided…to double their exposure to gold and gold stocks…[it] would still only represent 0.6%, [or] roughly $106 billion of their total assets, flooding into the gold market. That tiny increase from pension funds could, for example, buy every single company in the XAU (Philadelphia Gold/Silver Sector), every share of GLD (SPDR Gold Shares ETF), every share of GDX (Market Vectors Gold Miners ETF), and every share of GDXJ (Market Vectors Junior Gold Miners ETF) and, don’t forget, this is only one class of institutional investor. There are also hedge funds, insurance companies, sovereign wealth funds, private equity funds, private wealth funds, mutual funds, ETFs – and don’t forget millions of retail investors. Of course, it remains to be seen if any of these groups intend to increase their gold holdings. All this begs the next question…

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Where Would All This Gold Come From?
That’s a fair question because even though, by McGuire’s estimates, half of it would likely be invested in gold stocks – $53 billion – it would be hard to come up with another $53 billion worth of gold for investment purposes.

Many analysts look at the above ground figure of gold –176,000 tonnes (6.2 billion [troy] ounces) – and conclude there’s plenty of the shiny metal but the reality is that most of that is unavailable in investment form. We’re not going to melt down statues or go searching for lost gold as Cortez did to mint more Gold Eagles…

It gets worse: the investment supply of gold is actually falling. Here’s one example. London is the center of the gold market, and the Bank of England (BOE) holds literally tons of gold but look what’s happened to the amount held in other bank vaults.

Fig. #3
Change In Gold Vault Holdings 2011-2015 (in tons)

Source: LBMA.

…The Far East has lots of gold, especially China. Could we source some gold from them? The answer is probably not. The Shanghai Gold Exchange (SGE) trades in physical metal (unlike the Comex, which is largely done in futures contracts) and Chinese investors have withdrawn more gold from their exchange than ever before.

Fig. #4
Physical Gold Withdrawals From Shanghai Gold Exchange Since 2009

Source: Shanghai Gold Exchange.

It seems clear: Chinese investors are buying gold and taking delivery from the exchange itself. The exchange is closed to Westerners and has been for some time.

The supply problem is worse still. According to the World Gold Council’s “Gold Demand Trends” report for 2015, total gold supply fell nearly 7% from the third quarter of 2015 to the fourth quarter. Many mining executives and analysts agree that gold output has peaked for this cycle. As CNBC reported, “the lack of new assets and declining output at existing mines is expected to curb gold supply.”

Now Might Be The Time To Buy Gold

It’s possible we could be on the verge of a perfect storm for gold. Supply is tight and growing tighter and, if pension funds (and other institutional investors) enter this market for any reason, demand could spike. In that scenario, Economics 101 says the price could be forced higher…

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