The Great Physical Gold Supply And Demand Illusion
By Koos Jansen
Gold supply and demand data published by all primary consultancy firms is incomplete and misleading. The data falsely presents gold to be more of a commodity than a currency, having caused deep misconceptions with respect to the metal’s trading characteristics and price formation.
Numerous consultancy firms around the world, for example Thomson Reuters GFMS, Metals Focus, the World Gold Council and CPM Group, provide physical gold supply and demand statistics, accompanied by an analysis of these statistics in relation to the price of gold. As part of their analysis the firms present supply and demand balances that show how much gold is sold and bought globally, subdivided in several categories. It’s widely assumed these balances cover total physical supply and demand, which is incorrect as the most important category is excluded. The firms though, prefer not to share the subtle truth or their business models would be severely damaged.
The supply and demand balances by the firms portray gold to be more of a commodity than a currency, as the gist of the balances reflect how much metal is produced versus consumed – put differently, the firms mainly focus on how much gold is mined versus how much is sold in newly fabricated products. However, in reality gold is everlasting and cannot be consumed (used up), all that has ever been mined is still above ground carefully preserved in the form of bars, coins, jewelry, artifacts and industrial products. Partly because of this property the free market has chosen gold to be money thousands of years ago, and as money the majority of gold trade is conducted in above ground reserves. Indisputably, total gold supply and demand is far in excess of mine production and retail demand.
As most individual investors, fund managers, journalists, academics and precious metals analysts consider the balances by the firms to be complete, the global misconception regarding gold supply and demand is one of epic proportions. Physical gold is a profound anchor in our global financial system and thus it’s of utmost importance we understand the fine details of its trading characteristics.
Supply & Demand Metrics By The Firms
The firms can argue that the difference between what they present as supply and demand (S&D), as opposed to what I deem to be a more unadulterated approach of S&D is due to contrasting metrics. Accordingly, we’ll discuss their metrics to reveal their infirmity. In a nutshell, the firms only count the physical gold S&D flows that are easy to measure, while leaving out the most important part: institutional supply and demand.
Although the firms all have slightly different methodologies to measure S&D, from comparisons the numbers appear to be quite similar. For our further investigation we’ll spotlight the metrics and models by GFMS. The reason being, GFMS has been the only firm that was willing to share a full description of their methodology for publication – to be viewed here. Metals Focus (MF) provided a partial methodology, the World Gold Council and CPM Group declined to comment.
Let’s have a look at GFMS its S&D categories. On the supply side is included:
- Mine supply (newly mined gold)
- Scrap supply (gold sourced from old fabricated products)
On the demand side is include:
- Jewelry demand (gold content used in newly manufactured jewelry products bought locally at retail level, adjusted by jewelry exported and imported).
- Industrial demand (the volume of gold used in industrial applications, for example bonding wire, products used in semiconductors/electronics and dental alloys).
- Retail bar investment (the net volume of bars that are purchased by individual investors through retail channels).
- Coin investment (a combination of published data from mints and also a proprietary survey conducted by GFMS detailing where coins are sold).
The above four demand categories summed up are often referred to as “consumer demand” by the firms.
Furthermore GFMS includes:
- Net hedging (change in physical market impact of mining companies’ gold loans, forwards, and options positions)
- Net official sector (total central bank selling or buying)
- ETF inventory build (change in ETF inventory)
- Exchange inventory build (change in exchange inventory)
The last four categories can be either supply or demand. In example, when central banks (the official sector) in total are net sellers this will be listed as a negative demand figure, as is shown in the S&D balance by GFMS below from 2006 until 2009, when central banks in total are net buyers this will be listed as a positive demand figure, as is shown in the balance from 2010 until 2015. For a clear overview of the GFMS S&D balance please have a look at all line items below.
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