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On Monday, gold enjoyed its biggest one day jump in more than a year. It hit a four-week high as the precious metal staged a rebound. Gold finally broke through the $1,300 an ounce technical resistance level and finished above $1,335 an ounce.
Short-covering by technically-oriented traders and the perception that the Fed will continue QE for the foreseeable future are the short-term answers as to why gold had such a strong day. But there are solid fundamental reasons as to why gold should and will recover in price in the months ahead.
One key reason was pointed out several times by Money Morning’s Resource Specialist, Peter Krauth.
The reason? The growing divergence between the paper (futures, etc.) gold market and the actual market for physical gold.
Dislocations in Gold Markets
The dislocation in the gold market is beginning to show up even in the futures market.
Since gold is a quasi-currency, it is rarely in backwardation. That is, the near-term contract for gold rarely trades at a price above the longer term contracts.
But in recent days that has occurred for the first time since the 2008 financial crisis.
That indicates that physical demand for gold is far outweighing the physical supply of gold.
Economist Guillermo Barba told Reuters, “More and more people want their gold today, at a higher price, no matter that they can buy a future much cheaper.”
Just ask JPMorgan Chase (NYSE: JPM) about that. ZeroHedge reported last week that 90,311 ounces of the bank’s eligible gold was withdrawn in one day. This translates to 66 percent of the bank’s non-registered gold, leaving it with only 46,000 ounces of such gold in its vaults.
Quite a drop from the over three million ounces held in JPMorgan’s vault just two years ago.
Another indication of dislocation in the gold market is the rising lease rate for gold.
The lease rate is the amount it costs to borrow actual physical gold. The higher the rate, the tighter the market is. That is, the less physical gold supply there is in the marketplace.
Recently the one month gold lease rate jumped to 0.3 percent, the highest level since January 2009. The lease rate is up from just 0.1 percent a few weeks ago and a negative 0.2 percent last September.
This rapid climb in the lease rate (still at 0.27 percent) is another reflection of dwindling gold supplies in the face of resilient demand for physical gold.
China Loves Gold
Add to the growing dislocations in the paper gold market, the massive buying of gold by Asians, particularly the Chinese, and you have a recipe for higher prices.
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Money Morning Chief Investment Strategist Keith FitzGerald, in a recent article, showed how Chinese demand for the precious metal is by itself nearly equal to total worldwide gold mine production.
And so far this year, physical deliveries of gold (1,098 metric tons) on the Shanghai Gold Exchange account for 50 percent of global gold production.
In addition, China’s net imports of gold from Hong Kong continue to surge. In the last month reported, May, net imports surged 40 percent from the month earlier to 106 metric tons.
Let’s not forget either that China approved the first two gold-backed exchange traded products last month. The two products just had their subscription period close on July 12. This should add even more to the country’s already red-hot demand for gold.
A Vote of No Confidence or a Return to the Norm?
Perhaps the increasing demand for physical gold is a vote of no confidence in the world’s central banks’ money printing strategies.
If it is, it will be a mystery to Fed head Ben Bernanke. He said recently, “Nobody (namely Wall Street and central bankers) understands gold prices, and I don’t really pretend to understand them either.”
Or perhaps, it is a run on the gold bullion bank system where leverage ratios of 100-to-1 are quite common. This leverage could mean that, down the road, bullion banks like JPMorgan may not be able to make physical delivery of gold to those holders of gold contracts demanding physical delivery.
Or maybe it’s just a return to a time when gold made up a larger percentage portion of global assets.
According to German economist Ronald Stoeferle, ‘investable gold’ in the world currently totals $1.1 trillion. That is a mere 0.5 percent of cumulative assets around the globe.
That is a far cry from decades ago. Stoeferle’s figures show that in 1981, gold made up about 26 percent of global financial assets. In 1948, that number was even higher at 30 percent.
That means even a small move back toward historical levels for gold as a percentage of global financial assets will be significant. The bullion banks don’t have nearly enough gold in their vaults to meet demand. This could translate into much higher prices.
- Money Morning:
Has the Great Gold Crash Divorced Bullion From Futures Prices?
Gold Futures Hiccup Indicates Demand Outpacing Supply
JPM Eligible Gold Plummets 66% in One Day, Total Gold at Fresh All-Time Low
Gold Holds Luster in China as Imports From Hong Kong Rise in May
- Daily Reckoning Australia:
Is the Gold Price Set for an Explosive Rebound?