Gold In Flight!

October 12, 2013

Extra! Extra! Read All About It!

The Hong Kong gold import and export numbers for August are in and it’s clear that the unprecedented level of exports to Mainland China continues unabated.  On a net basis, Hong Kong shipped a generous 110.5 tonnes of gold to the Mainland for the month.

Similarly, it shipped 116 tonnes in July, 105 in June, and 109 in May. As lofty as these numbers are, it was March that set the yearly export record at 136 tonnes, drawing the attention of gold market observers to the East.

Summing it all up, the year-to-date export total through August is an extraordinary 745 tonnes. If gold exports from Hong Kong to the Mainland continue at their current pace for the remainder of the year, they will reach a mesmerizing 1,185 tonnes.

Putting this number into perspective, total global gold production for the trailing 12 months through June was roughly 2,400 tonnes (excluding China).  This suggests that at this pace, Hong Kong will send, just to Mainland China, an amount roughly equivalent to 50% of the rest of the world’s mined supply.

Consider this also; at the current pace, 2013 net exports to the Mainland will likely be more than double the 2012 figure of 558 tonnes.  And, for added perspective, 2012 net exports were roughly 50% higher than 2011, at about 372 tonnes.

This rapidly expanding gold flow into an insatiable China is what’s creating that loud sucking sound from the East that we wrote about in late August.

That Loud Sucking Sound Just got Way Louder

The numbers presented above are most certainly intriguing and should get any gold sector observer’s attention.  And therefore, these are the figures most news outlets focus on.  However, we are convinced that in doing so, they are missing the real story.

The real eye-popping forehead-wrinkling component of Hong Kong’s gold import/export figures, over the last few months, is NOT how much Hong Kong shipped to Mainland China; it is how much was shipped into Hong Kong by other countries.

If the 110.5 tonnes to Mainland China gets our attention, which it does, then a figure of 276 tonnes should make one’s eyes begin to water, and it did.  It’s not a typo.  Hong Kong imported a staggering 276 tonnes of gold from other countries (excluding China) in August.

Of that total, the aforementioned 110.5 tonnes went to the Mainland, only 15 tonnes went to other countries, and the remaining 151 tonnes remained in Hong Kong!

In just the first 8 months of this year, Hong Kong has imported an impressive 1,284 tonnes. At this pace, Hong Kong will likely import over 2,000 tonnes for the year.  And considering that global mined supply (excluding China) is only 2,400 tonnes, this leaves the rest of the world scrapping for the remaining 400 tonnes.

At this point, a visual aid will help convey the story better than we can.  Please marvel, as we did, at the following chart:

In the above chart, the monthly bars represent the total amount of gold imports to Hong Kong from other countries.

The record amounts going to the Mainland, which the media tends to focus on, are shown in red.  The amount of physical gold flowing into and staying in Hong Kong is shown in gold, which, as you can see, has been expanding rapidly since May.  Lastly, the small portion, shown in dark blue, is the minor amount that makes its way to other countries.

The 276 tonnes of total gold imports for August are an historic record by far and represents a 5 fold increase since January.  However, the 151 tonnes that remained in Hong Kong is also a record and represents an even larger 7 fold increase since January and a 113% increase over the previous month!

These figures underscore in dramatic fashion a theme we’ve been hammering away on in recent weeks.  That is, we are clearly witnessing an historic transformation of the global physical gold market and Hong Kong is at the center of it.  This is evidenced in the map below showing these gold flows.

It’s a Bird, it’s a Plane… it’s Flying Gold!

So where is all of this gold coming from?

We’ve previously reported that a major chunk of it is coming from Switzerland.  In the months since March, Switzerland has been shipping an average of 84 tonnes per month.  But, in August, this figure jumped dramatically, by 46%, to 133 tonnes, which is 14 times the amount shipped in January!

As you may know, Switzerland is a reputable destination for gold. This is because it has the world’s largest refining capacity, one of the world’s largest vault capacities, security and transportation infrastructure, and a mature market that has historically treated gold and its owners well.

As such, it is home to gold from mining companies, high net worth individuals, institutions, wealth managers, funds, as well as commercial and central banks.

Therefore, it’s not strange that Switzerland would be the source of a majority of Hong Kong’s imports.  What grabs our attention is the exponential growth in the size of these shipments.

We are also very curious about who is either selling or transferring this enormous amount of gold to Hong Kong.  In our prior article on the topic, we commented along with many others, how the U.K. exported a sizeable 798 tonnes of gold to Switzerland during just the first 6 months of the year.

Undoubtedly, this 798 tonnes is the source of some, if not most, of the jump in Swiss exports to Hong Kong.  So where is the rest coming from?

The U.S. has been the second largest exporter of gold to Hong Kong in recent months and shipped 32.6 tonnes in August.  Obviously this is much less than Switzerland, but it is still a significant amount.  It represents a 46% increase from the 22.4 tonnes shipped in July and a more than 3 fold increase from the 9.9 tonnes sent in January.

These U.S. numbers are intriguing because as the world’s 3rd largest gold producer, at 234 tonnes in 2012, they are on pace to produce only 214 tonnes in 2013.  This amounts to roughly 18 tonnes per month of production, which begs the question, where did the additional 14 tonnes come from?

Canada and Japan also deserve favorable mention.  Both countries exported 16.7 and 8.5 tonnes respectively.  This is interesting because up until May, both countries had not shipped more than 1 tonne in any given month.  But beginning in May, these exports began to rise, and in August, leaped to more than 3 times the previous month.

If we didn’t know any better, and we don’t, we get the impression that there has been a large-scale collaborative effort underway by certain Western powers (in which we include Japan) to prevent rapidly rising demand from driving the gold price up.

This would typically sound like conspiracy theory except for the fact that it’s been done before.

The London Gold Pool

In 1961, a group of 8 western central banks, led by the United States, joined together for this exact purpose. It was known as the London Gold Pool and also included Germany, the U.K., and Switzerland.

The purpose was to protect the old global fixed rate currency exchange mechanism established at Bretton Woods in the closing stages of World War II.  A rising gold price put this mechanism at risk.

The gold pool was successful to varying degrees for several years. But it was unsustainable, as are similar efforts today, and ultimately collapsed in a heap in 1968. The collapse featured runs on gold reserves, currency devaluations, geopolitical conflict, and the 2 week closure of the London gold market.

It was these events which ultimately led President Nixon to close the U.S. gold window in August 1971, and which caused the collapse of the Bretton Woods monetary system.

It was a tumultuous time in general but just like today, few realize that monetary upheaval was and is a significant part of geopolitical conflicts.

For a brief overview of these events, see the Wikipedia entry for the London Gold Pool.  However, the now deceased (R.I.P.) former Swiss banker and monetary historian Ferdinand Lips chronicles its history in great detail in his excellent book, “Gold Wars”.

Of course there is a great deal of evidence that the central bankers are at it again, but we’ve covered this in prior articles and I digress.  The purpose of today’s discussion is to highlight the fact that Western gold inventories are literally and figuratively in flight to Hong Kong on an historic scale.

Closing Thoughts

The reality is that China loves gold.  The west, in regards to gold, is fickle at best or plotting its demise at worst.  This is where the old adage, money goes where it is treated best comes into play.

As we discussed in last week’s piece, the Chinese have made the development of their gold markets a key strategic initiative as part of their last three 5-Year plans, beginning in 2000.  And unlike their counterparts in the West, the Chinese tend to deliver on the objectives spelled out in these plans, so we would not bet against them.

As a result, they are beginning to reap the fruit of their labors and the gold flows highlighted in today’s article are symbolic of this.

There is also an important consequence of this for the rest of the gold world.  As we mentioned earlier, this surge in Hong Kong gold imports to 276 tonnes exposes some significant issues in the global gold market.

This is because the rest of the world, excluding Mainland China and Hong Kong, consumes somewhere between 220 and 250 tonnes per month.  However, monthly mined production is only in the neighborhood of 200 tonnes, again excluding China’s production.

If we assumed that on average Hong Kong were to maintain a rate of imports of at least 200 tonnes per month, which it has over the last 6 months, then the global supply side of the equation is woefully short between 220 and 250 tonnes per month!

Even if Hong Kong imports only averaged 100 tonnes per month, it would still represent a shortage of 120 to 150 tonnes.

Clearly this supply gap is being met and then some, as reflected in the weak gold price environment.  Therefore, the question we are confronted with as investors is who will win this battle of attrition?

Will newly affluent China with an historic affinity for the yellow metal and its strategic initiatives to become the largest and most influential gold market in the world suddenly disappear and take its surging gold demand with it?

Or, will the western sellers of gold, whoever they are, be able to continually fill the yawning and ever-widening supply gap being created by Chinese demand? It is perhaps rational to believe that this could continue for a while longer. But, is it rational to believe that it can continue indefinitely? 

We believe the answer to this question is looming out there just over the horizon.  However, if we want to profit from these developments, it requires us to place our bets now while the gold price is weak and the prices of the embattled gold miners are at historic lows.

You know where we’re putting our money.

As a recent example of the leverage that selected gold miners can provide to the rising price of gold, we calculated the returns of the miners in our Model Portfolio from gold’s recent bottom on June 27th and it’s recent peak on August 28th.

During this two month period, gold rose 18% while the miner’s in our Model Portfolio, developed for subscribers, rose between 29% and 81%.  That’s better than a sharp stick in the eye!  Granted, this leverage works in both directions, however, given the battle lines drawn in today’s discussion, shouldn’t your portfolio have at least some exposure?

We think, shrewd investors would be well advised to accumulate the shares of the stronger gold miners now.


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Carlos Andres is the managing editor and chief analyst of both the Gold Miners and the Frontier Research Report investment newsletters. Both are natural resource and mining oriented publications focused on publicly-traded investment opportunities. Gold Miners covers large to mid-cap gold producers whereas the Frontier Research Report covers junior explorers operating in emerging and frontier markets. Carlos has been a natural resource analyst and investor for over 15 years.

The Federal Reserve Bank of New York holds the world's largest accumulation of monetary gold.

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