Gold Bullion Flows: Under the Hood

Gold Bullion's 2010 numbers are out. But look under the hood for what's really happening...

LOOKING AT THE LATEST figures from market-development group the World Gold Council – commissioned from GFMS, the London consultancy – we need to clarify certain points, writes Julian Phillips at the Gold Forecaster.

To understand the effect that the 2010 numbers will have on 2011, we need to look beneath the headline figures.

Last year's net "official sales" of gold were in fact 87.2 tonnes bought by central banks in the open market. With the International Monetary Fund's 403 tonne sale now complete, 2011 will find no such additional supplies available in large chunks to official buyers. And while we do not expect to see visible purchases by central banks in the market – except for Russia, who is still buying – we expect central-bank appetite to grow in 2011, however. The amount bought will now have to come from the open market in London, heart of the world's wholesale Gold Bullion market.

Moscow bought 3.4 tonnes in January, in line with the pattern they showed in 2010. The Russian authorities have stated they will continue buying upwards of 100 tonnes per annum. We are informed that the bulk of this is bought from local Gold Mining producers.

We believe China is following the same path (although using an intermediary agency) to keep such purchases out of sight. Once every 5 years these purchases are then reported, when that agency hands over the Gold Bullion it has bought in the previous five years. The last reported purchase over 5 years was an average of 91 tonnes per annum. Of course, the purchases may have been different over that period and may have matched growing local production. We do not have the information available to know what amount the People's Bank is buying locally or whether they are buying direct off the international market, and we will only know that in two years time, when they are likely to make their next public statement.

We know that China produced 340 tonnes last year and imported over 300 tonnes. The indications are that the People's Bank of China is buying in the international market too. This is important, because if the 640 tonnes for sale in China in 2010 was available to the local retail trade, then – guided by the figure of 200 tonnes suggested by UBS for the first two months of this year, ahead of the Chinese New Year – we expect this figure to rise by 70% in 2011. Hence, China could take in 1,088 tonnes for the private sector in 2011 if the demand remains at these levels.

As you can see above, the numbers from the WGC show a total of 579.6 tonnes used in the private market in China in 2011. An increase of 70% over that figure gives a total of 985 tonnes projected as private demand from China. This reinforces our belief that the PBOC is buying in the international market as well. Such an increase over 2010 is confirmed by the retail demand for gold in China since the Chinese New Year.

With double digit growth expected to continue for the next decade alongside a flat to growing developed world overall, jewelry and technology sector demand will either remain at current levels or rise. We must emphasize that the market has accepted these higher prices for Gold Bullion, and will continue to realize that gold is a precious metal. It remains the metal of choice for jewelry irrespective of the price.

Demand for Gold Bars and coins will likely continue at very high levels in 2011, as there are no efforts visible that will reinforce or reform the global monetary system. Food and energy inflation is expected to continue at high levels, irrespective of efforts by central banks to tackle inflation. This will continue to make gold attractive.

We do expect to see the shares of gold Exchange Traded Funds to be sold or redeemed as investors move their gold to another country or keep it at home. There remains a strong belief among the institutions owning gold that confiscation by government remains a strong possibility (but not for the same reasons as in 1933). Holding gold in banks in one's own country simply makes the process easier.

New Gold Mining production, in the meantime, is expected to rise by just over 100 tonnes in 2011, but there is not the flexibility or sufficiently large deposits to increase that figure. Many mining companies are struggling to replace mined resources as it is. We do expect to see a fall to almost zero of just over 100 tonnes in producer de-hedging in 2011, which will release that gold for other users.

Re-cycled gold should be re-named gold sold by current holders for this is what it is. In the developed world, profit seekers sell when they feel the price has peaked short, medium or long-term. In the emerging world, in particular India, long-term holders sell gold for personal situational reasons or because the Gold Price has risen too far or too fast. They then sell with the intention of buying that gold back once the price has made a new 'floor.

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