The Great Disconnect in the Paper and Physical Precious Metals Market

Over the last few months, precious metals investors have seen their net worth decline due to declining precious metals prices (GLD), (SLV). A lot of this decline in precious metals prices was due to a decrease in demand, which was the result of selling by hedge funds as the World Gold Council reported here.

First quarter gold demand of 963 tonnes was down 13% compared with Q1 2012 due to an outflow in the total gold ETF holdings of 177 tonnes. 2013 marks the first year in a decade where ETF's are actually selling gold. While ETF holdings were reduced, this selling has been countered by an increase in physical demand for gold by China and India. Total demand in China rose 20% to 294 tonnes in Q1 2013 as compared to Q1 2012 (50 tonnes increase).

This huge increase in demand for physical gold can be witnessed on Chart 1, which gives the net imports of gold from Hong Kong to China.

Chart 1: Net Gold Imports from Hong Kong to China

While Chinese demand for gold was strong, Indian demand increased at an even higher pace. The Indian demand for gold increased 27% on the same quarter last year to 257 tonnes.

On the supply side we see a total increase of 1% in the first quarter of 2013 as compared to Q1 2012. Mine production increased 4% while recycling of gold decreased 4%.

(click to enlarge)

Chart 2: ETF gold holdings in tonnes by region to end Q1 2013 (Source: World Gold Council)

So, the reason for the decline in precious metals prices is evident from an increase in supply (mine production increased) and a decrease in demand for gold (ETF outflows) (Chart 2). But there is an important point I need to make here. While the supply side is pretty constant at 1% increase, the demand side is the critical indicator we need to look at with its 13% decline. The decline was a result of hedge funds converting their gold holdings into equities. The Dow Jones (DIA) hit an all time high last week, fueled by a bullish prospect in the equity market of Japan, which on itself was a result of the massive Japanese monetary stimulus announced in April 2013. Although investors are cheering the bull market in equities, the macroeconomic conditions keep worsening. A few examples were a deterioration in PMI, capacity utilization, ISM manufacturing, vehicle sales, ADP employment, initial claims, PPI, mortgage applications, wages.

To see what this means for gold, read on here.

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Is the gold there?

As the gold stock at the COMEX keeps dropping precipitously, we get more and more signs that the banks and warehouses don't have any gold or silver available for delivery. Junk silver premiums made a new high of 27% today. Chow Tai Fook in Hong Kong is out of gold bars. It's only a matter of time now, when this will become mainstream media.

Edit: On 24 april, registered gold hit a new low and total gold stock hit a new low at 8 million ounces. This drop is the largest one in years. Something is happening.

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Correlation between Industrial Production Vs. CRB Metals Index

Thanks to Bob Garino, who commented on this article, I found out about the correlation between Industrial Production (manufacturing) and the CRB metals index.

Let's see if this correlation is correct.

I immediately see that from 1990 till 2000 the correlation doesn't fit. That period was a period where miners were in a bear market as metals prices declined and mining companies were getting worse and worse conditions for mining. Bonds were doing ok in that period.

So I'm a bit sceptical about this correlation. But I'll still add it to my list of correlations.

Chart 0: Industrial Production: Manufacturing

Chart 1: Industrial Production Index

Chart 2: CRB Metals Sub-Index

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The Trend in Base Metals based on Capacity Utilization and China Manufacturing PMI

To forecast the trend in the price of base metals we have a lot of indicators to look at. Two of the most important indicators to look at in my perspective are capacity utilization and the China manufacturing PMI.

Previously, I noticed that capacity utilization for mining in the U.S. was improving in November 2012, with the rate growing to 91.1%. Though, the problem is that the U.S. isn't that important anymore when talking about commodities. For example, in 2012 the emerging markets account for 75% of global iron ore consumption (Chart 1), while Asia, South America and Oceania account for more than 70% of global iron ore production (Chart 2). The same trend can be found in gold and silver production/consumption.

Chart 1: Iron Ore Consumption by Continent

Chart 2: Iron Ore Production by Continent

It would be wrong to only look at the capacity utilization of the U.S. to draw any conclusions on the prospects in the commodity market. It's essential to include China, South America and Australia/Canada into the equation.

To read the analysis, go here.

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Copper Bullish Move Confirmed

Dan Norcini from KWN Metals Wrap has confirmed my bullish prediction on the copper price:

"The copper market is in an uptrend. The copper market looks like it is going to break higher due to an improving economy in China and the improving housing market in the U.S. If copper is going to make a run higher, silver is going to go higher and the bears are going to have to cover."

Let's see what the coming months will bring. If Dan and I are right about a break out to the upside in the copper market, this could spark a run in the commodities and stock markets.

Chart 1 indicates that a huge move is about to come, as we are nearing the end of a wedge pattern.

Chart 1: Copper Price

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Bullish on Precious Metals

One very good indicator for higher precious metals prices is the lease rate.

As I predicted here, it was time to buy gold and silver. And now it's completely obvious that they will do good as lease rates are steadily increasing. I doubled my position in silver.

Chart 1: Gold Lease Rates

I wish I could show the silver lease rates, but Kitco is cheating on us, their chart only shows a flat line...

Chart 2: Silver Lease Rates (flat lines since 2 November 2012)

But all we need is the gold lease rate and then just extrapolate it to silver lease rates.

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Capacity Utilization Rate at 78.3% in September 2012

For all those who are concerned that precious metals will go down for the rest of this year, there is some light  at the end of the tunnel.

Capacity utilization rate for the total industry was up to 78.3% in September 2012 from 78% in August 2012. In particular, the mining industry recovered well, from 88.4% in August to 89.1% in September.

While looking at these numbers, I don't see precious metals crashing just yet.

Table 1: Capacity Utilization Rate

Chart 1: Capacity Utilization Rate

This statement can be confirmed if we look at the resource producing countries of Canada, Russia and Brazil. All of them are in a rising trend.

Chart 2: Brazil Capacity Utilization

Chart 3: Russia Capacity Utilization

Chart 4: Canada Capacity Utilization

The only country that isn't doing as well is Australia, where the capacity utilization rate declined over the entire year.

Chart 5: Australia Capacity Utilization

The probable reason for Australia's declining capacity utilization rate is a slowdown in China, which can also be seen in their capacity utilization rate, which is at a record low of 60% according to the IMF.

Chart 6: China Capacity Utilization Rate

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