Gold: When western supply meets Asian demand - Issue 2 of 5

TGR: Could you expand on why you believe China will soon be "driving the bus" for the global gold market?

BL: The Shanghai Gold Exchange (SGE), putatively a futures exchange, is actually a physical delivery mechanism for the Chinese market. Most of the gold traded on the SGE is actually delivered to end-users. As of the end of June, SGE reported nearly 1,100 tons of gold have been traded so far this year. That equates to all of the metal that had been traded on the SGE in 2012, which itself was a record year.

Put another way, at this rate of consumption, demand on the SGE this year will equal the entire newly mined global output projected for 2013. In effect, all of the new gold supply in the world is being consumed by a single exchange in a single nation.

China will soon exceed India as the largest source of gold demand in the world. There are demographic factors behind this: a deep cultural affinity for gold, a growing population and a rapidly growing middle class. The per-capita use for gold in China is still relatively low but has a lot of upside. As incomes grow in China, gold demand will grow on a per-capita basis even as the population grows. The potential for growth in the demand for gold is almost exponential.

TGR: Who in China is buying gold?

BL: The assumption is that the People's Bank of China is buying gold to build up the nation's gold reserves. China also has become the world's largest gold producer, yet none of the gold it produces ever gets exported.

There is tremendous upside potential in central bank buying of gold in China, in that China holds a huge amount of U.S. dollars in its foreign currency reserves. If it were to increase its gold reserves to the average level of most developed nations, it would quickly absorb all of the available metal in the global gold market.

TGR: Would the gold price be on an even stronger upward trajectory if India hadn't taken measures to curb gold buying?

BL: Yes, Indian demand would have been much stronger if its central bank hadn't increased the tariff in phases to 10%. Just as importantly, it imposed an 80/20 rule, which requires that 20% of all of the gold imported into India must be subsequently exported as finished goods. Those rules, imposed without explanation of how to follow them, effectively shut down Indian gold imports from the end of July through the end of August.

TGR: You recently wrote "Gold has bottomed. The market is set up for a large sharp rally when and if a short covering stampede is sparked." What could those sparks be?

BL: One appears to be the situation in Syria, although we don't know how that will develop.

A more important and fundamental driver for a short-covering rally would be the flow of economic data in the U.S., where economic growth had been showing signs recently of slowing. That slowdown, if it were confirmed, would eliminate any justification for tapering off the Federal Reserve's QE program. A growing consensus that QE will be here for a while will be the driver that gets the shorts to abandon their bearish gold positions.

TGR: How does all this translate to gold equities?

BL: The majors had a fairly good rebound and were outperforming gold until the Syria situation erupted. That touched off broader equity market selloffs, and the gold stocks were victimized.

Interest is just starting to filter down to the junior resource stocks. I'm not as negative on that subsector as some of my compatriots. Greed is the most powerful motivator in the investment markets, and greed will draw investors to the juniors like iron filings to a magnet if we see a sustained upward trend in gold and silver.