Big inflows into gold ETPs generate a rally, but one should remain cautious

Gold lease rates declined across the curve in the last few days (flattening the forward curve somewhat). The bullish sentiment has forced some gold short-sellers out, reducing demand to "borrow" gold.

Source: Kitco

The bullish sentiment is visible in the recent jump in GLD shares outstanding, indicating significant inflows into gold ETPs.

GLD shares outstanding (Bloomberg)

Bloomberg: - Gold ETP holdings overtook France’s reserves on Aug. 21 after rising 90.4 tons this year to 2,447.1 tons, data compiled by Bloomberg show. Only the U.S., Germany and Italy hold more, International Monetary Fund data show. The IMF itself holds 2,814 tons of bullion, placing it between Germany and Italy.

Billionaire John Paulson raised his stake in the SPDR Gold Trust, the biggest gold ETP, by 26 percent in the second quarter and George Soros more than doubled his holdings, U.S. Securities and Exchange Commission filings showed Aug. 14. Investors will buy 150 tons through ETPs this year and next, Barclays Plc estimates.

In spite of the reductions in short positions and tremendous inflows into ETPs, gold has not yet reached a speculative frenzy such as the one that existed in the short euro positioning or investment grade bonds last month. Should gold become a "crowded trade", we would be able to see it in the futures markets net positioning.

Bloomberg: - The increase in prices and ETP holdings has yet to be reflected in speculative wagers in U.S. futures markets. Hedge funds and other money managers cut bets on a rally by 58 percent since the end of February, U.S. Commodity Futures Trading Commission data show. The net-long position fell 4 percent in the week to Aug. 14 and is near the lowest since 2008.

So far the long gold bet seems to focus primarily on global stimulus, particularly from the Fed (as well as the ECB and PBoC). And clearly not everyone is sold on this easing being timely or large enough to weaken the dollar sufficiently and generate material incremental demand for gold. In fact short-term downside risks to gold remain if the expectations of Fed's "QE3" prove to be wrong.

There is also talk that the Republican party is going to make the return to gold standard in the US part of their campaign agenda. According to some estimates, returning to gold standard would send gold prices to $10K/oz, which encouraged some recent retail buying.

WSJ: - The committee drafting the Republican Party's platform before next week's convention included a proposal to establish a commission exploring the United States' return to a gold standard.

Republicans in Tampa, Fla., citing President Ronald Reagan's commission "to consider the feasibility of a metallic basis for U.S. currency," this week included the creation of "a similar commission to investigate possible ways to set a fixed value for the dollar," according to language of the proposal provided by a Republican National Committee spokeswoman. The Reagan commission "advised against such a move," the proposal noted.

Doing so is a nice idea in theory but it simply can not be implemented. There isn't enough gold out there for the Fed to buy in order to support the USD monetary base ($2.56 trillion). And any attempt to do so will destroy the US international competitiveness. It is a purely political move on behalf of the GOP to appeal to Ron Paul's supporters (which is also a good idea, but is not going to translate into higher gold prices).

Chicago Tribune: - Instead of planning for a gold standard return, the Republicans are trying to placate supporters at next week's RNC and to gain more firepower in the party's promoting responsible U.S. fiscal and monetary policies in the upcoming federal elections in November, analysts said.

Minutes from the Federal Reserve's latest meeting suggests the U.S. central bank will adopt stimulus fairly soon unless economic conditions improve dramatically. Some expect Fed Chairman Ben Bernanke could use his speech at the central bank's gathering in Jackson Hole, Wyoming, at the end of this month to send a strong message to markets.

At the same time gold demand fundamentals (outside of the QE expectations and the gold standard idea) have been fairly weak.

Bloomberg: - Physical demand is slowing elsewhere, with sales of American Eagle gold coins by the U.S. Mint dropping 49 percent to 30,500 ounces last month, the lowest since April. The mint sold 21,500 ounces so far in August, data on its website show.

Gold imports in India, last year’s biggest buyer, are set to fall as much as 50 percent in the September to December period from a year earlier, Prithviraj Kothari, president of the Bombay Bullion Association, said Aug. 21. Local prices reached a record today, data compiled by Bloomberg show. That may crimp demand at a time when a below-average monsoon in the country threatens rural incomes.

Gold should be a part of a long-horizon diversified portfolio, particularly given the developed nations' central banks willingness to (over)compensate for their governments' inability to generate growth and improve labor markets. Japan and the UK central bank balance sheets are growing, the ECB is getting ready to do the same, and the FOMC seems to be "trigger happy" as well. But in the short-term, given the risk of "disappointment" from the Fed and even from the ECB as well as weak physical demand fundamentals (particularly from emerging markets), one should remain cautious.

SoberLook.com