RESEARCH AND ANALYSIS
This Institutional Investor article How ETFs Alter the Dynamics of Gold is typical of
mainstream financial market commentary on gold ETFs. The idea is that gold
ETFs were a ��€�œgame changer for the gold industry��€,
making it easier for investors to buy gold and having a positive impact
on the gold price. It is intuitive and fits in with mainstream narratives
around ETFs in general, which have become a significant feature of financial
markets, and no doubt promoted by the World Gold Council (WGC), who sponsored
the major gold ETFs including GLD.
The reality, however, is a bit more complex. Let��€�™s take the
WGC��€�™s own figures from 2004 (when GLD first started trading) to
2012 (ignoring 2013 when gold ETFs divested 880t), a time period heavily
favouring the ETF game changer narrative. During that nine year period,
35,034 tonnes was supplied to the market in the form of newly mined gold and scrap.
The chart below shows where that gold went (net nine year demand; miners =
mine hedge book reductions).
The dominance of jewellery is probably of no surprise, but I doubt many
would be aware that physical bar and coin investment consumed 2.7 times more
gold than ETFs. The WGC figures are also skewed against the bar and coin
investment category given that the WGC includes Asian/Indian 24ct and low
premium jewellery as jewellery when one could argue that sort of buying is
more of an investment purchase rather than for adornment purposes like
Western jewellery buyers.
If we re classify only 50% of India and China consumer jewellery as
bar/coin investment (completely ignoring all other Asian countries), then
bar/coin investment style investment then accounts for over 11,400 tonnes of
physical gold compared to 2,600 tonnes of ETF investment.
A counter argument to the above might be that price is formed at the
margin, so it is not necessarily the total size of the categories that
matters, but which of those at the margin tips the supply/demand balance.
Certainly this was one of the reasons the WGC shifted its budget from
jewellery to ETFs as it saw investment demand as the swing factor in the gold
market. If gold ETFs have been behind gold price movements, we should expect
to see some correlation between their flows and the gold price, that is,
increasing inflows as the price rises and outflow as the price falls.
The table below is a simple correlation of the WGC��€�™s
quarterly figures for the period 2004 to 2013 (including the year ETFs showed
outflows while the gold price decline, again favouring the dominant
narrative) against the average quarterly gold price.
This shows that ETF demand is not correlated to the gold price, with a
slight skew to the negative. Physical bar and coin (and central bank
activity) however has a very high correlation to the gold price. So if you
wanted to forecast the gold price, correctly estimating these two demand
figures will give you a far better result than looking at ETF demand. The chart
below demonstrates this more clearly.
Here you can see that ETF demand was relatively constant during the gold
bull market, averaging 50 tonnes a quarter. In the early phase of the bull
market it was similar to coin and bar investment which was running at 100
tonnes a quarter. However the two diverge in 2008 at the time of the global
financial crisis, where you can see physical coin and bar buyers moving up to
around 300 tonnes a quarter while ETF demand showed little change. It is
clear that physical coin and bar investment was more of a driver of the gold
market post-2008 than ETFs, with ETFs only having a major impact in 2013.
So why do mainstream financial commentators focus on gold ETFs? Because
they are highly visible, giving daily trading volume and holding figures. The
less visible/frequent physical coin and bar market figures can��€�™t
compete for the attention of journalists needing to write something every
day. That��€�™s OK ��€�“ as Ben Hunt says, it is ��€�œthe business model
imperative of financial media��€ ��€�“ but just don��€�™t
make an investment decision based on it.
