Further to my Dec 6th post, Gene reposted it on his site and it drew a number of comments there as well as at on my post. Some additional commentary on those questions below.
One point was about the impact of miners. However the GFMS hedge book analysis has had miners slowly dehedging over time and has pretty much stopped, so that I don't consider a driver behind the position.
There were a lot of comments about demand in Asia and other places worldwide, however I was discussing Comex producer/merchants. It may come as a shock to Americans, but Comex is not the centre of the gold world. There is a lot of OTC hedging going on as well. So my assumption was that most of the Comex producer/merchant category is US/Western refiners/fabricators/distributors. Therefore, given the point about miners, understanding producer/merchant category is about understanding the downstream value adding process.
There was also some comments about how "if demand has dried up, the inventory should be up, not down, because demand normally drops much faster than production. Only when the producers manage to close down their mines will the inventory then drop but this usually takes a long time [so] inventory accumulating in the producer. So for the entire group of producers/merchants, if demand has dried up, the inventory should be up not down."
Firstly, producers/miners do not stockpile gold, they sell it as soon as they get it - they have tight margin and need cashflow. Downstream fabrication businesses also do not have the financial resources/funding to stockpile large amounts of gold in anticipation of demand (apart from the bullion banks themselves) hence they only hold what they need to support current sales.
All the gold produced is sold to investors one way or the other. The refineries are set up to produce 99.5% 400oz bars in bulk and cheaply. They process and clear this into the market efficiently where it ends up sitting in vaults owned by some investor - the industry itself does not sit on gold waiting for buyers, because there is always a buyer at the spot price.
There is a base amount of working inventory needed to support this "core" process. It is when you start value adding to that gold, refining it to 99.99%, casting it into smaller bars, or making blanks and then minting, that the industry's working inventory needs increase, because it is taking longer to transform the gold.
Hence when demand rises in these value added areas the "merchant" inventory and hedging needs will increase. When the demand reduces, the inventory reduces down to the base needed to support only 400oz bar manufacture.
Now this explanation is not meant as the sole reason why the producer/merchant category has went long. While the Perth Mint does not speculate on price, maybe it is common for other "merchants" to do so, although if that was the case, then why was the short position relatively stable during 2009-2010-2011 while a bull run was in place?
My point is that I think in the case of little producer hedging, merchant inventory needs (or lack thereof) would be a base macro trend/driver for the short position of this Comex category.