Posted 13th September 2022

The Rush to Physical Gold and Silver May Be Starting

The Rush to Physical Gold and Silver May Be Starting

“161 tonnes withdrawn from the SGE (Shanghai Gold Exchange) in July was the highest for July since 2015. That was a year of record Chinese gold consumption. Gold imports for July were 107 tonnes… Monthly imports have only been higher 4 other times since January 2020. Only in 2020 were imports significantly higher.”

The World Gold Council on Chinese gold demand in July

Note: In contrast to the term “withdrawal” on the SGE, with regard to the daily COMEX warehouse reports the “withdrawn” column mostly refers to the accounting entry by which gold is accounted for as moving between the “registered” and “eligible” accounts. Most of the time that gold remains inside the COMEX vault system. 

The only time gold or silver has actually been removed from COMEX custody was when the total amount of metal reported in the warehouse report declined. With the SGE, “withdrawal” means that the entities withdrawing are removing the gold from the SGE and taking it into their own possession.

China Imports on the Upward Trend

The People’s Bank of China (PBoC) oversees the Shanghai Gold Exchange. By law, all gold that is bought by any entity or individual in China – other than the PBoC -has to flow through the SGE. Unlike the meaning of the term “withdrawal” on the COMEX, SGE “withdrawal” represents gold that is purchased by and delivered to physical gold buyers in China. 

Along with this, June gold imports by China saw a sharp increase over the previous four months and were more than double the amount imported in June 2021. Activity on the SGE picked up in July and August plus the premiums for gold on the SGE have been running in the high teens to high $20s above the world spot price for a few weeks now, indicating heavy demand.

Furthermore, the gold import data only covers the gold that is imported into China through Hong Kong. In 2014, China opened Beijing and Shanghai for gold imports but does not disclose the import numbers through those ports to “help keep purchases by the world’s top bullion buyer (the PBoC) discreet at a time when it might be boosting official reserves“. 

Physical Market to Overcome Suppression?

The point here is that gold and silver may have been bottoming from the general precious metals sector downturn that began in August 2022. Gold, silver and mining stocks are as cheap relative to the level of the S&P 500 as at any time going back to the early 2000s. 

It’s my view that the demand in the physical gold and silver markets for bullion and coins that buyers want to be delivered to their possession is making it more difficult for the banks to use the derivatives market to manage the price of gold and silver.

My point here is that eventually, the physical market is going to overwhelm the ability of Western Central Banks and bullion banks to keep the prices of gold and silver suppressed for much longer.

This is likely why the COMEX bullion banks have eliminated their net short position in COMEX silver futures and have aggressively reduced their gross short exposure to COMEX gold futures.

Game Over. A run on Gold.

In addition to this, the BIS has substantially reduced its gold swap activity with Central Banks. The swap activity exposes the BIS to being short unallocated gold bars in London, meaning in an environment in which there’s a run on physical gold, the BIS would have problems getting its gold bars back to its own possession.

While the banks will not cease their effort to control the coming price rise in gold and silver, I believe the banks will go into a “managed retreat” mode, as we have seen intermittently over the last 22 years when gold and silver have experienced their best periodic rates of return. 

Once the Fed blinks, it’s game over and there will be a “run” on physical gold and silver, as we saw in 1979, 2010 and 2020. 

Impact of Inflation on Mining Companies

With regard to the earnings generation of producing mining companies, I’ve received several questions about my view on the degree to which cost inflation is affecting the mining costs of large miners.

Newmont’s stock was hammered after it missed estimates because of significantly higher than expected costs. I scanned the earnings reports of some other large producers (Agnico Eagle and Alamos Gold, among others). 

While their cash and AISC (all-in sustaining cost) were marginally higher in Q2 vs Q2 2021, they reported a healthy increase in revenues and net income due to increased production and cost containment measures implemented.

I think rising costs are specific to each company based on the ability of management to implement cost control measures and keep growing production. We saw what happened to Newmont with its costs relative to its revenue and production growth. But that’s why I do not invest in Newmont or Barrick.

However, efficiently run companies that have growing production costs are not the horror show the market has been expecting.

At some point, there will be a meaningful upward reset in the price of gold which will minimize the impact of cost inflation. Keep in mind that when the price of gold is above the AISC (which includes CAPEX spending required to maintain the assets), every dollar increase in the gold price drops down to operating and net income.


This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis. The views expressed in this article are those held by Dave Kranzler and not Kinesis.