Following Swiss gold import/export data this week it dawned on S&P Global Platts that there has been a glut of headlines this year suggesting that physical gold demand is on its knees. Which leads to another question: define physical? If metal moves, then surely that’s material demand, regardless of its end purpose?
“It doesn’t even need to be shipped. Metal just needs to exit a vault,” said one gold merchant.
The reason the question came to light is the fact that S&P Global Platts has been reporting physical demand — in key consumer India — as the worst in memory for 2016, year-to-date, with little sign of improvement.
Alongside that China, the world’s number one consumer, producer and importer, has also reported demand slacker than usual.
“India demand is nonsense. Indian [gold purchases are] price driven, not the other way round. Indian demand always drops when the price goes up. Yet when Indian [import] data is published saying [buying] is falling everyone assumes the price will go down on lower demand. It’s the wrong way round,” said the merchant, who stated that he can accurately predict monthly demand in India just by watching the price.
India, the world’s number two physical consumer, has had a dire year for gold demand; exactly what the government’s initiatives have been aiming for.
That has been added to by a stellar gold price in Q1 2016, and a volatile one in Q2.
The first graph shows the steady decline of India imports since the start of 2016, and the plunging discount. A fair correlation with the price rise, both in dollar and rupee-terms.
James Steel, senior analyst at HSBC, said in a research note June 22: “[Dollar gold] prices are up 20% from the beginning of the year, further eroding already weak physical demand, especially in India, but throughout the emerging world. Prices in India are at a very steep discount to world prices, eliminating much of the need for imports. Import levels are also down in China year-on-year.”
India relies nearly 100% on gold imports to satisfy demand. A market of roughly 800-900 mt of physical demand each year is forecast to see that drop to around 400-600 mt full year 2016.
So, where is the bullion going? Into the “sticky” palms of Exchange Traded Fund investors, it would seem.
One banker said, “[Define physical?] Is a good question. It is very vague. My view is that the convention is to regard ‘physical’ as jewelry plus any investment where the buyer takes delivery or direct ownership of the metal in the form of small bars or coins. But an ETF adding 10,000 oz to holdings is not.”
He went on to give a more detailed rationale: “If a gold dealer in Dubai imports 100 kg of kilobars on consignment from Switzerland, then next week sells 20 kg of kilobars to an Indian importer, but then in four weeks’ time returns the unsold 80 kg to Zurich, what part of that is physical demand? I would say only the 20 kg that went into India, not the 100 kg that moved from Switzerland to Dubai.”
This leads us back to this week’s Swiss data.
May Swiss data continues 2016 theme
Gold exports from Switzerland totaled 177.3 mt in May, up 20% from 147.8 mt reported in April, and the highest level since December, Swiss federal customs data showed June 21.
The figure is 69% higher than 105.1 mt reported a year earlier.
Exports to China were 36% higher on the month at 19 mt in May, while exports to Hong Kong were 2.5-times as large at 24 mt.
However, exports to India were down 16% on the month to 18.5 mt, while exports to the UK were down 12% to 69.5 mt.
The UK has been the biggest destination for Swiss gold exports this year, averaging over 60 mt/month since February, compared with average exports of less than 2 mt/month in 2015.
Growing investment demand for gold has seen a large flow of the metal into the UK this year, according to market participants.
Commerzbank said in a research note this week in reaction, “Switzerland exported a mere 61.5 mt of gold to India, China and Hong Kong in May. This constituted only a third of total Swiss gold exports. The main buyer was the United Kingdom, which has to do with the high level of ETF demand.”
One analyst told Platts, “It’s a problem that ‘physical’ demand has come to mean ‘non-investment demand’ or even ‘non institutional investment demand’ but ETFs — [alongside] bars and coins — [fall into the] physical [category, in my view].”
He added that, “One caveat is that you need to look at why ‘physical’ demand is weak/strong and if [it’s] not price related then it matters.”
A fund source recently told Platts, signaling that concern, that the spread between physical demand and investor demand is the widest he has ever seen, leaving him to see a major correction on the cards at some point.
A banker stated his opinion on the matter, “I think the big difference between ETF [purchases compared to] China/India is that ETF metal sits in the vault and can come back to the market in quantity [at any point].”
He added that, although you can see scrap flows when prices appreciate, “physical bullion [in any form, ex-dore] sold into China and India — especially India — is gone, never to be seen again.”
Platts gold assessment continues in deep discount
Platts 995 India gold [PGPI] was assessed June 23 at minus $40/troy oz, matching the steepest discount on record.
PGPI 995 India has averaged minus $17/tr oz so far this year. China has averaged around a modest premium of $2.30/tr oz.
“The days of $140 premiums in India and $40 in China are over; I doubt they’ll ever return,” said one trader.
The London Bullion Market Association Gold Price settled at $1,262.15/tr oz afternoon of June 23, from $1,310.75/tr oz a week ago. It started 2016 at $1,072.70/tr oz.
“Long term, India is critical to the price, but the ETF sits above all this, [still, true] physical uses drives long term demand [in my view],” one refiner source said via email.
The fact remains that bullion demand to India is currently on its knees, and causing some senior players much concern, but at the same time the outright price is holding.
One banker summed it up: “ETF flows are not physical, as even though bullion may ‘move,’ it’s not consumed, just stored for price reasons. In reality, there’s very little true physical consumption of gold in comparison to spec[ulative activity].”
Maybe the bigger question is how important India is now to the price environment for gold, and how much gold actually moves around the world rather than just from allocation to allocation?
“When gold moves into the unallocated/allocated vaults, it is not really physical at that point as it is not removed from the overall liquidity,” said the banker.
George King Cassell contributed to this post, including additional data and graphs.