Gold bullion flowing from West to East

2012-OCT-21

Earlier this month Eric Sprott circulated a paper, co-authored by him, which concluded that Western central banks have considerably less physical gold than they claim. It shows that since the year 2000 there has been a net increase in identifiable annual demand of 2,268 tonnes, and concludes that some supply, apart from mine output from the “free” world, must come from Western central banks – because there can be no other source.

This supply amounts to price suppression in the name of demonetising gold. Therefore, while minimal investment interest is shown in precious metals in the West, central bank selling and net jewellery liquidation (currently running at about 1,000 tonnes annually) are effectively supplying Asia with gold at artificially low prices in what amounts to a transfer of wealth.

We do not know precisely the extent to which this has happened, because available statistics only tell part of the story. The World Gold Council (WGC) has demand data going back only to 1992, and some of this is defined as actually measured (e.g. import statistics, mint and hallmarking data); otherwise it is only “indicated” on a trade-sample basis. Importantly, no statistics can capture change of ownership for vaulted gold. But we can get a feel for gold ownership shifts by recounting events since the US dollar finally dropped all links with gold in 1971.

In 1971 bullion investment was still effectively banned in the US (except for foreign coins), and investment in the UK and a number of other countries was also more or less coins only. It is estimated that all existing coins today amount to about 3,500 tonnes.

The oil crisis of the 1970s led to substantial bullion-buying by the enriched Middle Eastern states. This continued through the 1980s and into the 1990s. Meanwhile conservative Swiss investment managers, who collectively were the largest holders of bullion, were replaced by a new generation of managers who by 2000 had disposed of nearly all of it, as had investment managers everywhere in the West. Even today very few investment managers have bullion in their clients’ portfolios. This gold quietly disappeared into Arab and Asian hands, and into jewellery fabrication boosted by low prices. However, even in 1992 when the WGC statistics started, Asian demand ex-Japan dominated markets, absorbing 1,650 tonnes – over twice that of the developed markets.

At that time private gold ownership in developed markets was predominantly in jewellery form. This accumulation is reversing as a consequence of higher prices and financial stress in some nations. Bullion investment remains unfashionable, and remarkably few people have even seen a gold coin, let alone possessed one. But the last decade has seen the growth of securitised gold in the form of exchange-traded funds and other listed vehicles, amounting to about 2,800 tonnes. While the deteriorating outlook for paper currencies has sparked a partial move into gold, much of this is in unallocated accounts with bullion banks or in synthetic derivatives.

The message behind the shift of wealth from advanced nations to Asia is that we are left with no “Plan B” in the event of a monetary crisis. A global collapse of paper money, which is inevitable if current monetary policies are not reversed, will give Asians considerable wealth relative to the rest of us.

History will surely judge the central banker’s promotion of ephemeral paper at the expense of gold in the harshest terms.