Dubai a gold rush winner whatever your perspective

Investors from Shanghai to Sharjah are in the grip of a gold rush so frantic it puts the Yukon to shame.

Hang on a minute, I thought the gold rush was all over, that the bull market that pushed prices up to more than US$1,900 from $850 in 2008 collapsed in spectacular style just a month ago with a panic sell-off that called to mind 1929 on Wall Street. What's going on?

It seems that trading in the gold market, like all great sports, is a game of two halves.

On the one hand you have derivatives - the world of futures and options, exchange-traded funds and hedge funds that trade gold in almost unimaginably large volumes. It is this market that sparked the big sell-off last month, when one fund dropped 100 tonnes of gold in the blink of an eye and 300 tonnes followed it out the door.

The gold derivatives market behaves much like any other, with traders in front of screens following trends illuminated in red and green blinking lights. With one emotionless button push after another they buy or sell billions of dollars worth of whatever is on their order book for the day, whether it be orange juice, Google shares, T-bills or gold.

But then there is the physical gold market. A lolloping beast that relies upon great steel safes filled with gleaming yellow bars, fiery furnaces tended by soot-smudged smiths, armed guards in bombproof lorries and the secretive buyer who nervously holds his wealth as close as he can.

Surely a much more fitting market for something so ancient, mysterious and evocative as gold.

Physical demand for the yellow metal has increased so much since the price crashed last month that the supply of heavy gold bars is running low in Chicago, London, Switzerland, Singapore - wherever they are stored.

Stocks started running low in Singapore a couple of weeks ago and traders began to take note.

The trend has accelerated since then, with reports this week out of Chicago that point to a real rush for physical gold.

Stocks held at the Comex warehouses in the Windy City have dropped to a five-year low in the past few days as buyers in India and China are knocking down the doors of every gold storage vault on Earth, so hungry are they for the metal.

What is baffling, perhaps more so to those unfamiliar with the ins and outs of the gold market, is that the price of gold has failed to leave bear territory despite this renewed buying frenzy. The price has gone up a wee bit, then it has fallen again, in the bumping along the bottom pattern that some might call a dead cat's bounce.

The fact is the physical gold market can never come close to the derivatives market in terms of volumes to correct the historic sell-off that occurred last month.

But, just like that sell-off set records, so the physical buying spree we are seeing today is setting precedents of its own.

What is happening in the physical gold market is a complete reversal of the trend that has driven the gold price for the past six or seven years.

All gold trading demands a physical presence of metal for a deal to be done - not like some markets where bubbles inflate and burst as traders buy and sell in the ether.

The gold derivatives market relies on large bars that are stored in vaults in London, Chicago and Switzerland, whereas the physical market relies on smaller kilo bars and minted coins that need to be forged from those same large bars.

So what we are seeing at the moment is a shift from a derivatives-led gold market to a physically led market. The large bars are leaving London, Chicago and Switzerland to be melted down and recast into smaller bars and coins for Asian investors to buy.

That process takes time, several days perhaps, a lag that creates arbitrage opportunities for physical gold traders who are currently making a tidy return on this changing trend.

It also appears, from anecdotal evidence at least, that Dubai has emerged as a real winner in this reversal of gold fortunes.

There are five gold refiners in the UAE and all of them - so I am told by numerous reliable sources - are operating at full capacity. That's three shifts a day around the clock seven days a week - to satisfy the increased demand for physical gold.

The UAE is the perfect waypoint between the large bar storage vaults in Europe and the United States and the customers in India and China - who are responsible for 60 per cent of physical gold purchases.

And what is more, we have the state-of-the-art facilities to convert those large bars into the smaller, purified quantities the Asian investors want.

That is not to say the bad times are over for gold. The derivatives market may yet sell again, which some fear would lead to a greater price drop than we saw last month. But if that happens, the same Asian buyers in the physical market will surely step in to take advantage of a buying opportunity.

So up and down, Dubai seems to have succeeded in casting itself as the winner in the gold market - whether the bulls or the bears are in charge.