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Sprott's Thoughts

Henry Bonner

Eric Sprott: Gold Shortage Coming, Data Shows

Eric Sprott, Founder and Chairman of Sprott Asset Management, said recently that he expects a “significant re-rating of the gold price” due to high physical demand from China and India, coupled with a gold supply shortfall. The effect, which he calls the “Chinese Gold Vortex,” is rapidly taking physical gold from West to East. When the West runs out of gold, the price should go much higher, he believes. I recently spoke with him on the phone about his near-term views.

Hello Eric, what do you see happening today in the metals markets?

Eric Sprott: I am very excited about developments in the gold and silver markets today. I have been speculating since late 2012 that Western central banks could be running out of gold. I put the sell-off in gold and silver in 2013 to the fact that the Western banks needed a way to generate physical gold supplies. As the metals prices went down, there was a lot of liquidation of gold which increased the supply by an estimated 900 tonnes last year.

Let’s look at the figures. The annual supply of gold is around 4,300 tonnes. 3,000 tonnes come from mining and the other 1,300 tonnes or so from recycled material2. In 2013, an additional 900 tonnes came onto the market from ETFs that were being liquidated – a supply increase of around 21%.

Quite frankly, I believe this was all orchestrated in order to create this supply. During the time when the price was knocked down, a tsunami of buying started. India bought 336 tonnes from April to June of 20133. I’m sure that the central bankers went to the Reserve Bank of India and said: “You’ve got to stop people from buying gold.”

Of course, the Reserve Bank of India went on to create rule after rule to try to stop people from buying gold. They managed to get monthly imports of gold down to around 20 tonnes from its normal imports of around 80 tonnes per month. Obviously, those official numbers leave out smuggling, which probably makes up a very large amount of gold imported into India.

At the same time that Indians were buying, the Chinese were jumping in, too. The mine supply, excluding China and Russia which tend not to export any gold, is only around 190 tonnes per month. You had Indians buying 50 tonnes and China buying 90 tonnes4 – that does not leave much left over for the rest of the world. Blogger Koos Jansen, from In Gold We Trust, says that Chinese demand alone last year was 2,000 tonnes5. So demand has far outstripped supply.

There is also interesting news coming from Dubai concerning this supply/demand imbalance. A group there is building a gold refinery that can process 1,400 tonnes of gold per year6. Well, the current refining capacity in the world is around 6,000 tonnes. Somebody is going to add another 20 percent of capacity. The supply falls far short of that at only 4,300 tonnes. Why is this refining capacity so much higher than the official supply of gold?

I believe that the volume of gold being exchanged must therefore be much higher than the official number of 4,300. To me, it’s just another piece to the puzzle, and it all points to central banks surreptitiously supplying gold to China. Gold from central banks, held in LBMA-sized bars, is being recast into kilogram-sized bars, which are preferred in Asia. It all points to this: gold is flooding out of central banks in the West and into Asia’s coffers.

Another piece to the puzzle is Germany’s current effort to repatriate its gold supposedly held by the U.S. So far, it has only received 5 tonnes back from the U.S. Treasury7. They’ve asked for 300 tonnes back over 7 years. That would imply around 3.6 tonnes per month.

It’s worth noting that the U.S. is supposedly the largest holder of physical gold in the world. Its books should contain 1,500 tonnes held for Germany8 and 8,100 metric tonnes of its own9. So why have they only delivered 5 tonnes over the last year?

We now get monthly data from Switzerland about where its gold imports come from. In February, 114 metric tonnes came from the UK10 – a country which does not produce any gold. So where did that gold come from? Who did it belong to? The most obvious answer would be the Bank of England, or ETF holdings.

Data from the U.S. offers a similar problem. The U.S. Geological Survey showed that the U.S. exported 80 tonnes of gold in January11. The U.S. only mines 20 tonnes a month12, and imports another 20. So where did the extra 40 tonnes of exports come from? Who supplied it? The answer is most likely the U.S. Treasury.

The whole reason for Western central banks, particularly the U.S. to supply gold to Asia is to suppress the price of physical gold. Most people realize that low interest rates and printing money will eventually be very bad for the U.S. dollar. One thing that would tip people off to imminent danger to the U.S. dollar would be a much higher gold price. Keeping gold’s price low is just part of the financial policy.

All this money printing is designed to help the U.S. address its massive obligations, which include its current debts and off-balance sheet obligations of around 80 trillion dollars. Their annual revenues are only around 2.8 trillion dollars and their expenditures are 3.5 trillion13. Everyone knows there’s no way they can afford to keep going and cover their obligations. This leaves money printing to cover the gap.

Ultimately, we will find out the extent of manipulation in the gold market when someone finally fails – most probably the U.S. running out of gold to supply the market. And I don’t think we are far off here.

Do you think that there is merit to the argument that other sources of gold exist that could explain how so much gold is being delivered to China? Such as smuggling or clandestine exports through the shadow banking system in China?

Well, I don’t think that is likely. The Chinese government controls all exports of gold and since they are a net buyer, they probably would not allow any exports.

The amounts of gold involved are so large that clandestine sources seem unlikely. There is only one government in the world that even owns 4,000 tonnes – that’s the U.S., supposedly.

I think it comes down to the powers that be simply trying to keep things under control. The dollar is coming under extreme pressure here, and it looks to have broken down here, in fact. That should have people going into gold.

The U.S. GDP growth, which was expected to be around 0.1%, will probably be revised even lower for the first quarter of 201414. I do not believe that any economic recovery is really occurring, because the middle class is simply being routed. We are seeing no real wage gains and inflation is well beyond reported CPI numbers, which are just a joke. In the real world, we all know inflation is much higher.

There’s no rational explanation, in my opinion, of where the gold is coming from apart from central banks.

What do you see happening in the broad stock market? Are we in a bubble phase? Will problems in the general stock market cause people to rush into the dollar?

Well, there’s going to be a point where countries will have to assess each of the currencies on their own merits. As you know, I live in Canada, and I can assure you that when I look at the data that the U.S. supplies, the dollar will lose a lot of value. I am sure that countries like China and Russia would look at the same data and come to the same conclusion.

China and Russia look like they could already be turning their backs on the dollar. Brazil and India have complained about the printing of money and the disastrous effects on currencies. They could also be turning their back on the dollar.

I am not so sure that the dollar will remain in the same high esteem as the market has historically given it.

In the broad stock market, things have not started to change just yet, but we are starting to see some cracks appear. Housing numbers have been quite weak. We’ve seen tech stocks come under attack. Some of the major banks have warnings on their trading levels going forward. Those stocks seem to be breaking. So the generals are coming under pressure.

I’m not sure when a decline will start happening, but I feel safe in predicting that within  24 months, the value of these stocks will be much lower than today. I don’t think it’s nearly as safe as the banking interests would tell you.

How do you think that the situation in the Ukraine might affect gold?

Well, I imagine that people in the area – in countries like Romania or Bulgaria, or in the Ukraine itself – would be thinking about putting some of their money in gold right now. Obviously it does bring people into the gold market.

I prefer not to fall back on these sorts of possibilities as reasons to own gold. These are ‘black swans’ for gold. I prefer to focus on the physical shortage argument for owning gold, because I believe the case there is black and white. The means and motive for suppressing the price of gold are well-known. And the physical will win the day.

Now, gold will benefit from black swans – a war, governments going broke or the recession getting worse. These could happen, but things are changing in the precious metals markets regardless of these events.  

Do you believe that the physical shortage argument applies to platinum and palladium as well?

Absolutely. In fact, I find the case for platinum and palladium even more compelling than anything else right now. When you think that the top supplier of these metals is Russia, and that the second biggest is South Africa, which is on strike, I find it surprising that the price of platinum and palladium has not exploded.

I also see what goes on in the paper markets, however. The commercials are taking on an increasing short position in both of these metals, which is pushing the metals lower. A recovery in platinum and palladium would certainly help all precious metals move higher, including gold and silver.

I think that there’s a great case to be made in platinum and palladium.

What do you make of the lawsuits taking place in New York over alleged gold manipulation?

I’ve been very closely involved in the news surrounding these lawsuits. I’ve read through the court cases, and spoke with some of the lawyers involved before the suits were filed to see what kind of work they had done. Knowing what the prize could be, these lawyers have put a lot of effort into creating a bona fide class action case.

If the suit is authorized, we will be able to go look through records and find out, for instance, who sold 100 percent of the annual supply of silver in one day and 50 percent of the gold supply in one day. The way I see it, where there’s smoke there should be fire.

I think that these are not frivolous lawsuits. As many as 20 firms showed up in court two days ago to press for the classification as a class-action lawsuit. There should be a lot of money and power directed at getting this thing to court. Based on the data that we have looked at, there will be some revelations.

I would point back to the comment by Germany’s regulator, BaFin, who said that possible manipulation in gold could be worse than LIBOR. I am actually surprised by the massive sums that are traded each day in gold. The gains to be made by gaming the system are very substantial – we’re talking billions of dollars, and the fixing process appears to be a complete joke. When the Chairs of the committee to fix the price of gold in London got together, about four or five people knew where the price was going to be post-fixing. They were probably the same people doing all the trading around it, including the derivatives trading, which is an easier way to make money because it is a much bigger market.

I hope that the proceedings take place and that we are able to see evidence of who was doing what in these markets over the last 10 years.

Eric Sprott has more than 40 years of experience in the investment industry. After earning his designation as a chartered accountant, Eric entered the investment industry as a research analyst at Merrill Lynch. In 1981, he founded Sprott Securities (now called Cormark Securities Inc.), which today is one of Canada’s largest independently owned securities firms. In 2001, Eric established Sprott Asset Management Inc. He is Chairman and President of Sprott Inc., a publicly-traded company based in Toronto, Canada with over $7 billion in assets under management.

1 GFMS gold survey 2014. Page 8

2 GFMS gold survey 2014. Page 10

3 http://www.ibtimes.com/india-hikes-gold-import-duties-record-10-percent-it-struggles-record-trade-deficit-1382721

4 GFMS gold survey 2014

5 http://www.ingoldwetrust.ch/world-gold-council-clueless-on-chinese-gold-demand-2

6 http://in.reuters.com/article/2014/05/05/emirates-dubai-gold-idINKBN0DL0LJ20140505

7 http://www.mining.com/the-fed-only-gave-germany-back-5-tonnes-of-gold-in-over-a-year-82989/

8 http://www.forbes.com/sites/afontevecchia/2013/01/16/germany-repatriating-gold-from-ny-paris-in-case-of-a-currency-crisis/

9 http://www.fms.treas.gov/gold/current.html

10 http://www.ezv.admin.ch/themen/04096/04101/05233/05672/index.html?lang=en

11 USGS Gold Mineral Industry Surveys

12 http://minerals.usgs.gov/minerals/pubs/commodity/gold/mis-201401-gold.pdf

13 http://www.treasury.gov/press-center/press-releases/Pages/jl2197.aspx

14 http://www.bloomberg.com/news/2014-05-06/first-quarter-u-s-economic-slump-looking-uglier-by-the-day.html

 

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