Imports to India, the biggest gold consumer by far, were running at five times average levels, according to investment bank UBS. Chinese smallholders used their May Day holiday not to head for the beach, as this column naively suggested last week, but to flood the gold dealers in Hong Kong. Turkey bought more gold in April than in any month since the fateful days of August 2008. And so on.
Were the financial pros back in New York and London impressed by this spontaneous outpouring of gold love? Not a bit.
What might Wall Street know that moms and pops in developing markets do not? One hint comes from an interesting bit of research published by French bank BNP Paribas last week. It seems — and we should all be thrilled to know this — that structured finance has infected the ancient art of gold trading through an instrument known as a “reverse convertible note.”
This involves a financial institution lending cash to an asset buyer, at an elevated interest rate, but in return granting the buyer a put option to sell the lender said asset at a pre-agreed price. Investopedia tells us that RCNs “provide a predictable, steady income that can outpace traditional returns.”
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Unless of course the value of the underlying asset falls sharply and the put option triggers. This is just what happened when gold started to tank a few weeks ago. “It’s hard to determine what was the biggest cause for gold’s decline, but structured products played a part in exacerbating the downward spiral,” BNP’s chief of commodity sales, Guillaume Picot, told Bloomberg.
But this latest necromancy with RCNs is just more proof of a bigger picture problem: professional and retail gold buyers are living in separate worlds psychically if not geographically. The pros measure gold’s performance against that of other assets, particularly stocks, and stocks have been killing gold for going on two years now. The S&P 500 SPX -0.37% has climbed by nearly 40% since Oct. 2011; the dominant SPDR Gold Shares ETF GLD -1.16% has lost 15%.
At a certain point all but the hard-core gold bugs will give up on the idea of the metal outperforming. The mid-April market panic seems to have been that point. All the more so as the main intellectual argument for gold — that central bank credit expansion will dilute “fiat” currencies and spur a new bout of monetary inflation — keeps stubbornly failing to come true.
The retail buyers lining up to grab gold at “bargain” prices don’t care about or trust stock markets, for the most part. In India, they are acting on a time-honored tradition that precious metal is a woman’s mad money, her potential salvation in the event of marital disaster or widowhood. Gold stashes are passed down from mother to daughter, or showered on brides as a wearable testament of financial independence. So consumers will always buy more if the price looks affordable.
The retail purchaser has the numbers in the world gold equation. ETF investors sold off 174 tons of metal in April, a record for them and enough to spur a market crash. But jewelry and gold-coin/bar buyers scooped up 222 tons in an average month last year. So a bull run at the shops can easily offset a bear patch on the Street in terms of raw demand.
But the pros can move the market more quickly with cascading instantaneous sell-offs of fund holdings or collateral on their reverse convertibles. Thus, the gold price plunged by 13% in two sessions between April 11-15, and has gained back only half that despite the masses’ positive response.
At the moment the market is in stalemate, having done basically nothing last week. The near-term outlook would have to be called a bit bearish. Institutional investors look determined to shave weightings on gold so long as equities stay buoyant. The retail frenzy has to calm eventually, especially as India’s spring wedding season is winding down this month.