The Asian Giant Stampeding into Gold

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I recently discussed how traders were stampeding out of gold as a result of rising interest rates and the threat of evaporating monetary fluid that was lubricating markets.

Hovering around $1,200 at the beginning of July, the gold price has completely disconnected from the precious metal's fundamentals in my opinion.

Prices have fallen too far out of fear, but the drivers for gold are still in place.

My friend and highly respected analyst, Gregory Weldon, highlighted an important point about rising rates in the U.S. The coupon on the nation's $13.22 trillion debt averages 1.88 percent with an average maturity of 5.4 years.

As interest rates rise, debt will be rolled over at a higher rate, making the burden even greater than it already is. This suggests a likely tipping point for Treasuries. Will the Federal Reserve suppress yields at that "line in the sand?"

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In this environment, gold should remain attractive. However, as the West flees the precious metal, another set of gold buyers has come forward with the aim to preserve wealth.

Take a look at the chart below which shows total gold production compared to the gold deliveries on the COMEX and the Shanghai Gold Exchange. In May, gold imports into the Asian giant rose to the second-highest level ever.

While mining production is around 1,134 tons so far this year, gold delivery on the Shanghai Gold Exchange is 918 tons. This is strikingly in contrast to the gold delivery on the COMEX, which stands at only 103 tons year-to-date as of the end of May.

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In fact, this year's demand is so significant that the physical gold delivered on the Shanghai Gold Exchange through May is almost all of the official gold reserves in China!

As George Topping of Stifel Nicolaus puts it, "Annualizing 2013 year-to-date figures, China's imports would be equivalent to 50 percent of [world] mine production."

China may be devouring even more of the supply in the future if the price of gold remains subdued. I've been talking with several gold company executives, who tell me they are seeing squeezed margins because of lower grade finds, as well as governments raising taxes or increasing royalty rates.

The top priority for these miners today is cost control, focusing their efforts on viable projects that have all-in costs of less than $1,000 per ounce of gold. If spending is too expensive, exploration is cut and production is halted.

This is an extremely conservative amount, as some gold mining projects in certain countries come in significantly higher. The CEO of Gold Fields recently indicated that the average all-in cost in Africa is $1,500!

This is a similar phenomenon to the supply of natural gas recently. When there were huge discoveries in the commodity, companies immediately halted drilling. There's a notable difference in drilling gas versus mining gold, though: The natural gas cycle is shorter and measured in months, so there can be a relatively quick recovery in supply. When gold companies cut production, the restart cycle can take decades.

To me, these supply and demand drivers point to a sustained higher gold price.

With gold prices at or below production costs, gold is extremely attractive. Find out the Best Reasons to Own Gold Now.

All opinions expressed and data provided are subject to change without notice. Some of these opinions may not be appropriate to every investor.

[Editor's Note: Frank Holmes is CEO and chief investment officer of U.S. Global Investors Inc., which manages a diversified family of mutual funds and hedge funds specializing in natural resources, emerging markets and infrastructure. He has been profiled by Fortune, Barron's, The Financial Times and other publications. If you want commentary and analysis from Holmes and the rest of the U.S. Global Investors team delivered to your inbox every Friday, sign up to receive the weekly Investor Alert at www.usfunds.com.]

Join the conversation. Click here to jump to comments…

  1. ralf | July 12, 2013

    Hi there,
    The story about the FED was told many time, but nobody wants to see the truth.
    Everything is manipulated by the 7 SISTERS since 1910!!!!
    One book only is telling the truth, wrtten by E. Griffin – The creature from Jekyll Island.
    This is a MUST READ BOOK.
    Good Luck
    Ralf

  2. H. Craig Bradley | July 12, 2013

    AUSTERITY IS COMING TO AMERICA

    In the long term, we should expect higher Treasury interest rates and increasing pressure on the Federal budget. It is forecast that by 2017 about 30% of the entire Federal annual budget will be consumed by interest payments alone on a $25 Trillion dollar national debt.

    This will be cripple to the American economy and the American people will quickly lose confidence in our government and its leaders. When confidence disappears, markets tank. These developments will force Congress to actually do something for a change: make those hard budget choices they keep avoiding. Greek Austerity and urban civil unrest is coming to America later in this decade. Prepare yourself!

    • Edana Estenes | July 14, 2013

      It will happen in in the fall months of 2015. More like the middle of this decade. And it will be much worse than anyone can imagine. I could go into a lot of detail, but I will refrain. Just prepare yourself, because you will not recognize the American that we are about to become.

  3. H. Craig Bradley | July 12, 2013

    PEAK EXUBERANCE

    Market crashes are by definition often caused by unforeseen or unrecognized factors which eventually overwhelm the entire stock market. Since today's global markets are highly interrelated and correlated, everything (including gold) moves in tandem during panics. The unnoticed just quietly creeps-in, unnoticed as termites, and begins eating-away at the market's fundamentals.

    Naturally, investor sentiment is at its peak exuberance while this process is going on. Often, peak exuberance is also accompanied by new all time highs in the stock market indexes, at least. Subsequent crashes are always a big surprise to the mass of investors.

  4. Henry Hriiczko | July 13, 2013

    Simply overlooked by the majority, whom by the way that is the masses who are paying for the Government criminals Negligence and complicity, the 7 sisters are underground already and the storm is pounding the blood out the next 50 generations, already dead, they said, with their "the masses" grandchildrens sweat and blood Taxed to Death,. with that said, The underground Vent systems has a big flaw that the7 sisters overlooked,
    Shit rolls downhill and the airvents are wide open, denver International airport underground civilazation compound is the P trap on the wesetern seaboards collective shit bowl. No escapeng it Politicians Bankers & Criminal scumbags, Our Leaders….Losers more like it.
    Life is fair at the end of the day. Karma Rules right Next to Gods..

  5. Brad M | July 17, 2013

    The game is over. The US babyboomers ( richest generation in world history probably ) are past their peak consumption years and there is nothing left to replace that run. Today's youth leaves college on average $40k to $50k in debt to enter a job market where there are little oppurtunities and stagnating wages… no credit or savings or income needed to really get the housing, retail and other markets going again. Look at recent new housing application numbers and retail as well. Also, just think of how many jobs and industries all this technology we love is replacing and how fast it is really happening. Time for major economic adjustments in society ( aka a depression ). After he 1929 crash there was a period of leveling off and even inflation as there were attempts to prop it all up, but it only worked for so long. We had our crash in 2008 and now we have once again witnessed the attempts to prop it up. Look at these facts plus the numbers on stock margin debt as % of GDP and we are in for a rough ride. Another October stock market collapse, followed by deflation?! And this time they wont be able to prop it up again.

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