Physical gold demand has been up, and the supply may not be able to keep up with it due to production constraints and other issues.
Q4 2019 hedge fund letters, conferences and more
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Barriers to physical gold demand
Strategjst Nicky Shiels of Scotiabank said in a note on Friday that India is the top nation for physical gold demand, and it has gone on lockdown. About 1.5 billion people have unplugged, and trading is halted for three weeks. In China and much of the rest of Asia, operations and trading are starting to normalize. In the U.S. and Europe, demand for physical gold in the form of gold coins and kilobars is climbing.
There are widespread coronavirus-related shutdowns affecting the gold supply chain right now, largely in South America, especially Peru, Argentina, and Chili and in Canada. Further, there has been major disruption to global transportation because airline and cargo traffic has been reduced, although not all cargo carriers are on lockdown.
Switzerland's big three refineries produce about one-third of the world's physical gold supply for demand, and they all suspended operations a week before CE's first notice day. Africa's only gold refinery is operating at reduced capacity. Other refineries are closed or operating at reduced capacity as well. Some mints in North America also have partially closed operations.
Impact of physical gold demand supply and demand disruptions
Shiels notes that the shutdowns within the gold supply chain have been very ill-timed due to the ramp in physical gold demand among both retail and institutional investors in the U.S. and Europe. The shutdowns also come just ahead of the April futures roll period, the end of the quarter, and during a time of overall market illiquidity and stresses on the U.S. dollar. Further, Shiels said investor inflows into derivative or gold paper products has resulted in major disruptions in the gold market.
The strategist added that with most commodities, net supply and demand disruptions impact fundamental balances and directional pricing. However, with gold, the effects are seen in major dislocation between physical and paper prices and within pricing for physical gold.
The gap between COMEX and physical gold prices widened to nearly $100 at a time when the premium should've been closer to zero due to the supposed shortage in physical gold. Shiels also said the futures curve for the yellow metal should historically always be in contango market. However, it displayed signs if switching into backwardation intermittently in the April to June spread.
No real shortages of the metal
The Scotiabank strategist also said there is no actual shortage of physical gold. Instead, there are some big bottlenecks on certain products. According to Shiels, if there were a major shortage, then spot gold prices would be trading higher than futures prices.
Shiels estimates that the current disruption to production is only around 1%. Further, there is plenty of stock above ground that could be enticed out at higher prices. The strategist estimates that there is about 90 million ounces sitting in known vaults, like with exchange-traded funds. About 6.3 billion ounces or 60 times the annual production of gold is being held in jewelry, official sector and private investments.
"Gold pricing is driven asymmetrically more so by the incremental demand (not supply), given this backdrop of ample above ground stocks," Shiels wrote. "In that sense it is less a commodity, and more so a hedge against (<insert fear here>) and what the next marginal player is willing to pay."
Shiels also said overall physical gold demand is strong in the wrong locations or in the wrong form. There's metal sitting where it isn't needed in Asia and Africa during a time when transportation networks are being disrupted.