There is a tale of two stories in the gold market – the financial market and the physical market (individual demand for the actual metal).    The gold market has changed dramatically with the introduction of GLD (a gold exchange traded fund – ETF) in November of 2004.   For the first time, investors could buy gold through a quasi-mutual fund format.   This made it easier for large institutions and mangers to invest in gold.   The result has been spectacular and GLD actually became the largest ETF in the country with close to $78 billion in assets in August 2011.    However, this year hedge funds and individuals have sold GLD and the assets have shrunk by 50% and now stand at $39 billion.   The below chart demonstrates how these redemptions have weighed on the price of gold this year.

Most interesting is that the physical demand for gold is skyrocketing.  As cash moved out of GLD, total bar and coin demand for physical gold rose an astounding 56% during the second quarter.  The demand from China alone is eye-popping. Chinese citizens are not permitted to invest outside of the country and have very limited areas to invest.   The few areas they can invest are the Chinese stock market which is down more than 67% from its high, real estate which is overbuilt with empty cities, or keep it in the bank where they lose money to inflation.   Gold ends up being the de-facto investment choice.   The Shanghai Gold Exchange is 7x larger than the New York COMEX Exchange.   At current levels, physical delivery of gold in China is more than 100% of the global mine production this year.    This dichotomy between the physical and financial gold assets has been occurring all year.   In the end, we believe the physical demand will drive the financial gold market higher.    This is beginning to materialize as the financial gold markets have started to rebound.  Junior gold mining shares (GDXJ) have increased 20% this week while over half the gold mining newsletter writers are still bearish on the asset.      

Thoughts on recent market movements

Yesterday’s stock market drop was triggered by poor earnings reports from Cisco and Wal-Mart.   Wal-Mart actually had a decline in sales of 0.3% in same store sales when expectations were for a 1% increase.   This quote from Wal-Mart’s CEO, Bill Simon, sums up why retail sales in the US are weak, “The 2 percent payroll tax increase continues to impact our customer.”   In addition to Wal-Mart, Cisco came out with earnings that caused the stock to fall 7%.   This quote yesterday from company CEO, John Chambers, says it all, “This recovery is more mixed and inconsistent than the others I have seen.  The environment in terms of our business is improving slightly but nowhere near the pace that we want.”

As we stated in our 2^nd quarter update, many of the financial markets are priced for perfection.   Assets like gold do offer opportunity, but this is still an environment where managing risk is of utmost importance. 

Sincerely,

Your THOR Team