Gold heads lower, no physical demand to pick up investor selling

Gold headed lower over the duration of the week started May 23, with bullish confidence dented by mutterings from the US Federal Reserve Board of an earlier-than-market-expects interest hike and restricted physical demand to pick up any slack. Is gold's bull run over or just getting going? Attitude this week was certainly mixed.

One senior bullion banker this week said that he sees zero physical demand from key buyers, India and China.

He said that the price could easily correct back towards $1,150/tr oz and didn't rule out a pullback towards $1,050/tr oz.

"I don't think $1,050 is impossible in the short term. There is not much going for it [gold] these days," he said.

Using the London Bullion Market Association Gold Price as a benchmark, dollar bullion fell 2.3% this week, to $1,221.25/troy oz May 27 from $1,250.40/tr oz the morning of May 23.

Inflows into Exchange Traded Funds remain elevated, but appear to be coming off the boil for the first time in 2016.

The world's largest gold-backed ETF, SPDR Gold Trust, showed outflows of 0.6 mt for the week ending May 27, compared with inflows of 18.13 mt for the week ending May 20. This is the first decline in the ETF since 29 April. Total fund holdings now weigh in at 868.7 mt.

Q1 global gold demand rose 21% on year, according to the most recent data published by gold lobby group the World Gold council, with transactions driven largely by ETF inflows.

In stark contrast, physical consumption demand for gold over the first quarter of the year was down 24% from Q1 2015.

Who picks up the slack?

With investor demand for gold showing signs of slowing, it is easy to see why banks such as UBS are now discussing more negative outlooks for the metal.

"Lack of physical uptake for gold bullion could leave the price vulnerable to corrections as investors lack any gauge on fundamentals" the bank's analyst Joni Teves said on May 27.

The world's number one and two consumers, China and India, have been largely absent from the market in 2016. More so India, which has shied away from the higher price in both dollar and rupee terms and also been hit by industrial action owing to proposed increased taxation.

"In addition to physical buyers not being there to help absorb supply, it also means investors don't have the natural gauge to assess whether a floor is nearby," analyst at the Swiss bank Joni Teves told clients May 27.

S&P Global Platts Gold Premium India 995 was assessed May 27 at $9/tr oz from $12/tr oz May 26.

One contact on the ground said that any dip would need to be closer to $1,100/tr oz to get India interested.

The summer is traditionally a slow period for physical gold purchases.

Gold flows, but in another direction: data

Swiss import data released May 24 made for interesting reading, and confirmed lingering rumors that gold was now flowing from East to West, led by the UK, which imported 53% of Switzerland's total April exports.

When compared to major gold importers (China, India, USA, UAE, Hong Kong and Singapore), the UK has been the largest importer from Switzerland in March and April.

Exports to China in April fell 7.3% on year, and Indian exports were down a huge 57.2% on year.

The picture is not so simple however. Commerzbank pointed out that the Swiss data is not the complete story.

"China imported 68.8 mt of gold from Hong Kong on a net basis in April. Although this was 4% down on the previous month, it was 32% up on last April," suggesting that China is still consuming large amounts of gold.

By way of comparison, the UK imported 78.8 mt of gold from Switzerland, China imported 14 mt, giving China a net total of 82.8 mt.

It is likely safe to assume that China is still importing very significant volumes of gold.

Chinese physical demand still sluggish, for now

However, physical consumer demand in China is reportedly subdued, as market turmoil and a depreciating yuan early in the year have depressed appetite.

Commerzbank noted that it expects Chinese and Indian weakness in demand to be a temporary phenomenon.

Over the first half of 2016 China has been very direct about intentions to develop its own gold market.

ICBC Standard Bank acquired Barclays' 2,000 mt London gold vault May 11, making a clear statement that it wants a bigger piece of the international bullion pie.

Also, the People's Bank of China is continuing to buy up large volumes of gold. Speaking at a recent precious metals forum in London, WGC's Roland Wang said: "The [bank] buys 10-20 mt/month, and has been building reserves for a while."

Wang outlined that with the Shanghai Gold Exchange now the largest physical gold exchange in the world, the Chinese government's aim is to further develop the country's gold market.

"It's no secret, the Chinese want to control the international gold market," said one banker.

India: Worst year in memory

India is normally the second largest gold consumer, but so far this year a number of unique issues have crippled demand for physical gold.

Strikes by jewelers in response to new excise duties levied on imported jewelry in March ground the business to a halt. In addition the poor monsoon has depressed demand, rural communities often use revenue generated from crops to buy gold as a proxy current account.

One banker said "what we used to do in a day, we do in a week,”  highlighting how soft the domestic market is.

Most are describing 2016 as the worst year in memory for Indian physical gold demand.

Some sources on the ground remain optimistic that things will change, but a deeper price correction is needed.

For now that wish appears to be coming true, but seemingly not enough.

Perhaps it's more of a case of the old adage, sell in May...