Gold Retreats Despite Strong Physical Demand, Tight Supplies

By Peter A. Grant

Over the past several weeks, market conditions have been about as crazy as I have ever seen them in over 20-years as a market analyst. As global financial markets teetered on the brink of complete meltdown -- a meltdown that could indeed still happen -- we at USAGOLD - Centennial Precious Metals have been witness to one of biggest gold rushes in history.
All of our brokers, including myself, have been working extended hours in an effort to accommodate absolutely unprecedented demand for physical gold as worried investors scrambled for the safest of safe-haven assets. There have been plenty of 12-hour days in recent weeks, days were it seemed we were on the phones for 12-hours straight.
We frequently worked through meals, even though Mike and Marie were bringing in food each day. George, who works the late-shift on the desk, was often here until 1:00 or 2:00 in the morning trying to keep up with correspondences and paperwork. There were days that for every order I took, I would end up with 6 or 7 calls to return.
Call volume has been at record highs to be sure, but we've also seen unprecedented web traffic at USAGOLD.com. We've been seeing absolutely mind-boggling numbers. Every time we increased the capacity on our website to accommodate increased traffic, it was immediately filled.
I personally have been leaving the office each day exhausted, starving, probably dehydrated and perhaps a tad over caffeinated. However, this is not a whoa-is-me broker's sob story, I love being busy. I just want you to get a feel for what it's been like around here.
Amidst this absolutely insatiable demand for physical gold, we've seen supplies tighten further. The mints of the world are having a hard time keeping up with demand. There is in fact a shortage of available physical gold, but that does not mean there is a complete absence of the yellow metal.
Over the past 35-years we have built a very robust supply chain. Physical gold is increasingly scarce, but we do have supply. Overall, the industry as a whole is doing a remarkable job in handling the situation.
In a hallway conversation yesterday morning, we all concluded that based on supply/demand dynamics, gold should be trading around $1100 to $1200 an ounce. News that the Senate had passed the latest TARP proposal drove gold down even further today. The yellow metal is grossly under priced at these levels.
One of my market contacts reported this morning that Barclays was aggressively buying $1200 Dec calls. It seems they may have a similar view with respect to a fair market value for gold.
Of course getting the bailout plan through the House is going to be the real challenge. If the House fails to approve the latest plan, all of today's losses in the gold market are likely to be quickly retraced. Perhaps that will be the trigger that sends the yellow metal on its way to its fair market value.
Even if TARP is passed, the long-term implications for the dollar are extremely negative. Since gold and the dollar have a negative correlation, passage of TARP would be very positive for gold.
Initial jobless claims for the week ended 27-Sep were 497k, above market expectations. Factory orders for Aug were down 4%, well below market expectations. The ISM manufacturing index for Sep came out yesterday at 43.5%, recording the biggest m/m plunge since 1984.
All of these data are extremely recessionary and do not bode well for the stock market. Expectations are growing that the Fed will cut interest rates whether TARP is passed or not in an effort to mitigate the recession that we may already be in.
Oct Fed funds futures have fully priced in a 25bp rate cut. Odds of a 50bp rate cut this month are running over 80%.
The prospect of a rate cut along with monetary expansion on a massive scale is also extremely dollar negative and inflationary. Imagine a recession where inflation rather than deflation is the primary concern.
All of these concerns, along with ongoing systemic risks, are going to continue to drive strong safe-haven buying interest in gold. Pressure is building on the market and I wouldn't be surprised to see more record days like we saw back on 17-Sep when gold surged more than $80 in one day.
One consistent theme I've heard from dozens of clients in recent weeks is that they wished they had been accumulating physical gold more diligently over the years. There were certainly ample opportunities to buy gold in much more 'normal' market conditions over the past 14-months as the current economic crisis unfolded.
Over the past several weeks, they have been forced to join panicky buyers in a mad rush to preserve their wealth as global credit markets threatened to seize completely. This in turn has heightened fears of bank failures and a collapse of the stock market.
The immediate storm will pass at some point. Higher prices will bring supplies back to the market, and while I think the gold market has entered a new paradigm, things will return to some semblance of order. It is in those times, when all is relatively quiet, that you should be adding to your physical gold holdings.
Buy now because you need the diversification and wealth protection aspects afforded by physical gold. However, accumulate on a consistent and regular basis in order to maintain the proper level of diversification.
When I collapse in a heap at the end of a long day of selling gold, I sleep fitfully knowing that I am providing a valuable service to my clients. I also sleep easily because I am a gold owner myself.