The first ETF was launched just 5 years ago by the World Gold Council and State Street Securities. Since then it has returned 150% and assets have grown to $40bn. In the meantime, many other physically backed gold funds have started although State Streets’ is still one of the largest. Physically backed ETF’s bought some 20% of new gold production this year, double the figure of last year said the FT in Short View last week. Driven in part by ETF buying, gold reached over US$1150 per ounce last week and supporters point to fear of inflation, the falling value of the dollar, central bank buying and long term decline in reserves and production as reasons why the gold price will continue to rise.
In the long run they may be right but we question how far this current Bull Run has to go. Fundamentals often get sidelined in periods of intense speculative activity but in the end they tend to re-assert themselves. In the short term, there are negative factors that have largely been ignored by investors looking for the next quick buck. On the supply side GFMS, the precious metals consultancy, estimates in this article that global gold mine production will rise 3.7% in 2009 to 2,502 metric tons, largely because of strong Indonesian production. In the third quarter it rose 6% to 670 metric tons and scrap sales rose 31% to 283 metric tons although these were still down from the first quarter. Inflows into gold exchange traded funds slowed sharply this year, down 72% in the third quarter from last year to 41.4 metric tons and 27% lower than the previous three months – increasing the amount of material available on the market. Admittedly October and early November have shown an increase flow into ETF’s again which, in part, is what has fueled the current rally.
On the buy side, consumer demand is also down with large year over year drops recorded in India and the Middle East according to this article in the FT. Only China has shown growth in consumer demand up 12% from the same time last year to 120.2 metric tons for wider consumption and 8% for jewelry to 93.5 metric tons spurred by government urgings to invest in physical gold and the 60th anniversary of the founding of the People’s Republic of China on October 1 providing a boost to sales. However, China was the only market to see positive growth in gold jewelry demand in the third quarter while India, still the world’s largest gold jewelry market, saw demand fall to 111.6 metric tons in the third quarter, down 42% year-on-year. World-wide demand for jewelry fell 30% year on year to 473.5 metric tons in the third quarter while total demand (including investment spending and industrial consumption) for gold fell 34% to 800.3 metric tons.
Investment demand will likely remain firm in the run up to the end of the year as gold continues to be seen as a hedge against a weakening dollar and from jewelry demand in the traditionally strong fourth quarter but come first quarter 2010 when physical demand is traditionally low we could see support falling away and the price coming off. The fundamental support for gold, at least in the coming year is almost purely as a dollar play. Inflation is low, supply is sufficient unless central banks step in en masse, the main demand is only going to come from investors in physically backed ETF’s continuing to buy into the gold story.