China's Golden Appetite

Jim Brown
 
Printer Friendly Version

Gold traders celebrated last week on news of increased demand by China. News that gold imports into China increased +41% to 1,176.4 metric tons in 2013 helped to power the short squeeze. That was a record high and makes China the number one gold market in the world for the first time and surpassing India.

To put that number into perspective global gold production in 2012 was only 2,700 metric tons, which was also a record by 11 tons. That means China imported roughly 43% of the world's production.

Gold traders celebrated last week on news of increased demand by China. Gold has rallied from $1260 to $1320 over the last week and showing no signs of slowing down. The $1318 close on Friday was over the 200-day average at $1309 and the first time to trade over the 200-day since February 2013.

There is a major short squeeze in progress and the gold bugs are showing up in droves. They point to the constant stream of weaker than expected economic data, the currency fluctuations in the global markets and their expectations for the Fed to halt the taper and even increase QE as the country slips back into recession later this year. Multiple gold miners have shut in reserves with a high cost of production until prices return to profitable levels. Barrick Gold wrote down reserves by $11.5 billion with $2.82 billion in Q4 alone. I am not going to expound on those points but the short squeeze is making believers out of a new flurry of gold investors.

After a double bottom at $1185 the price of gold is nearing crucial resistance at $1350. A breakout there would be very bullish. Gold posted its best weekly gain since August. An analyst at Stifel Nicolaus said the break over the 200-day targets $1600. Goldman Sachs reiterated their forecast for a drop to $1050 by year end.

Silver also broke out of three month consolidation to close at $21.48 and over the 200-day average at $21.12. Silver has been a laggard but a move over $23 could be powerful. This was the best week for silver since March 2008.



Silver has been a laggard to gold in recent months but it will not last. When silver is used it is consumed and destroyed. Only a small amount of silver, about 25%, is reclaimed through recycling. Silver is used in things like smartphones, flat panel TVs, electronic circuit boards, jewelry and coins just to name a few. The cost to mine silver today is between $20-$22 an ounce according to Dundee Capital and David Morgan.

Mines with a higher cost of production are shutting down. The Pitarrilla silver project in Mexico was supposed to begin mining but Silver Standard delayed the construction due to the depressed price of silver. The Pitarrilla mine was originally expected to produce 15 million ounces a year beginning in 2016. Now the project is off the table because of the low prices.

Silver stockpiles around the world are depleting. Existing mines are winding down. Mines are like oil wells. They don't produce forever. You dig them out, process the ore and then close them. It may take a decade or more for that process to complete for a new mine but most mines today have been in existence for a long time. Starting a new mine and complying with all the environmental rules is becoming a prohibitive expense.

The majority of mined silver today exists only in the physically backed ETFs like the SLV (323 million ounces), PSLV (49 million), SIVR (18 million) and CEF (77 million). There is also about 182 million ounces in COMEX vaults that back existing futures contracts.

Mine production of silver in 2012 was 787 million ounces. Consumption was 1,048 million ounces. The difference was made up from government inventory sales of 7 million ounces and silver scrap of 254 million ounces. As mine supply begins to decline the price of silver is going higher simply due to supply and demand.

Consumption of silver in 2012 looked like this.

Millions of ounces
Industrial applications 465.9
Photography 57.8
Jewelry 185.6
Silverware 44.9
Coins & Medals 92.7
Investment silver 160.0

I have been pounding the table on silver as an investment for several years. Silver rallied to just under $50 in 2011 before the global economic rebound floundered. As global economies sank to minimal growth and Europe slipped into recession the demand for silver and gold declined sharply. Now that demand is returning I expect to see prices rebound but they are dependent in the short term on global growth. Long term they will be dependent on falling mine production and demand growth. Eventually the two major factors are going to collide. Mine production will decline to the point where supply will not keep pace with demand. Prices will rise and that will stimulate new mine production but the life cycle on a new mine is in years from concept to production. This will allow prices to rise sharply before that new production comes online.

Numerous "silver bugs" predict $50 silver before the end of the decade and several see $100 silver. The gold/silver price ratio has historically been about 16:1. If gold were to rebound to $1,600 that would equate to $100 silver IF the ratio returns. The current ratio is a whopping 61:1 and significantly out of the historical norms especially with the demand for silver rising and production slowing. This was prompted by the safe haven run to gold after the Great Recession. Gold retained its luster as a storehouse of value while silver declined on falling industrial demand. As the global economy improves those factors will reverse. Gold will lose its safe haven luster and silver demand will rise.

I strongly advise readers to add some physical silver to their portfolio. That can be in circulated silver coins, silver rounds, silver eagles or a physical silver ETF like the SLV. If you go for the actual silver coins like I do then buy the common U.S. Silver Eagles, silver rounds from a reputable source like Apmex.com or U.S. 90% silver coins dated before 1965. DO NOT BUY any form of graded coin. Buy only common circulated coins/rounds where possible.

Apmex.com sells 100 coin bags of U.S. silver dollars as low as $2,450. One ounce 2014 Silver Eagles were $2,550 for 100 on Friday. Once ounce silver rounds were $2,300 per 100 on Friday. Obviously the rounds were the best value but the other two options are U.S. minted coins rather than third party products. Therefore they carry a slight premium.

I checked as I was writing this article and you could buy a roll (20) of U.S. Peace silver dollars on Ebay for as low as $413 including shipping. Search "Peace silver dollars roll" and buy from somebody with a lot of positive feedback. I have bought thousands of silver coins from Ebay sellers without any problems. A local gun show is also a source of silver dollars and rounds. Check Google for a listing of shows in your area.

Natural Gas

Natural gas inventories declined -237 Bcf last week to a total of 1,686 Bcf in storage. Next week is sure to show another huge decline. At the present rate of usage there is only about 7 weeks of supply left. The odds are very low we will see seven more weeks of record cold but stranger things have happened.

Ironically with gas prices at four year highs the number of active gas drilling rigs declined by -14 last week to 337 and the lowest level in three months. Since rig usage and planned drilling is laid out months in advance the E&P companies have not been able to shift their focus back to natural gas. By the time they do it will be spring and gas prices will have declined significantly.


Market

The markets moved closer to their recent highs with the Nasdaq making a new 13 year high by one point. The bulls are back but analysts are warning that the retest of the highs could produce a negative event. The term double top has cropped up numerous times over the last week.

Only time will tell if that warning is valid but for the time being sentiment has turned bullish despite the weak economics and flood of earnings warnings.

Jim Brown

Send Jim an email

Archives:200920102011201220132014201520162017