The topic that generates by far the greatest disagreement in the investment community, just after whether we will have inflation or deflation, is whether gold is cheap or expensive. And as much as gold is a speculative commodity, it does have roots in fundamental supply and demand. A good source in demystifying the fundamentals in the gold industry, The World Gold Council, has released its summary analysis of investment trends, and market and economic influences in the gold market in Q4 of 2009.
Key observations from the report:
Investors bought another 30 tonnes of gold via Exchange Traded Funds (ETFs) in the fourth quarter, bringing total inflows for the year to 573 tonnes. GFMS believes the global over-the-counter market was an important source of new net demand in Q4 2009. They note a strong pick up in OTC activity from September onwards driven by “non-traditional” investors taking out long-term positions. The more speculative end of investment demand also remained strong, with total non-commercial and non-reportable net long positions on COMEX increasing by 27.0%, on average, to 22.0 million ounces.
Investment flows, dollar-hedging, inflation protection, and central bank buying all played a role in propelling the gold price to new records. Looking into 2010, a growing number of investors are worried about price stability, as the global economy shows increasing signs of recovery. The large sums of money supply that reached the market in 2008 are creating concerns that inflation may be looming. There is a strong, lagged, relationship between changes in global money supply and changes in the gold price.
Preliminary reports on fourth quarter jewellery trends in India suggest a continuation of the cautious recovery from the low demand levels in Q1 2009, helped by seasonal factors. Moreover, levels of jewellery recycling have subsided from the highs experienced at the end of 2008 and beginning of 2009. In China, the outlook remains resilient as the economy recovers, whilst the US market is still being impacted by higher US$ gold prices. Anecdotal evidence suggests global levels of recycling remained subdued despite the rise in the gold price. Separately, the pattern of behaviour among central banks and official sector institutions continued its recently established trend, as sales under the third Central Bank Gold Agreement (CBGA3) slowed to a negligible rate, whilst banks outside of the agreement clocked up another quarter of net purchases, according to our estimates.
The gold price rose for the ninth consecutive year in 2009 to US$1087.50/oz on the London PM fix by December end, from US$869.50/oz at the end of the previous year. This represented a 25.0% increase in the price of the yellow metal during 2009. Similarly, the average price of gold rose 11.5% to US$972.35/oz, from an average of US$871.96/oz during 2008.
Whilst market volatility has eased relative to 2008, gold price volatility increased in the fourth quarter to an annualised average of 19.7% from 15.0% in the previous quarter. Gold price volatility reached a peak of 26.0% on 21 December, measured on a 22-day rolling basis, as the price of gold fell from its historic peak of US$1212.50/ oz on 2 December to US$1084/oz on 22 December, at the London PM fix
- Exchange Traded Funds
Investors bought another 30 tonnes of gold via Exchange Traded Funds in Q4, bringing total inflows for the year to 573 tonnes. This took the total amount of gold in the ETFs that we monitor to a record 1,762 tonnes, worth US$62 billion at the year-end gold price. SPDR® Gold Shares, or GLD as it is known, listed on the NYSE Arca and cross-listed in Mexico, Singapore, Tokyo and Hong Kong recorded the strongest inflows during the fourth quarter, adding 38.3 tonnes, bringing the total to 1,133.6 tonnes (worth US$40.2 billion) in assets. It was followed by ETFS Physical Swiss Gold Shares—which was launched in September 2009 and is listed in the NYSE—adding 6.4 tonnes during Q4 to a total 9.5 tonnes in assets. iShares Comex Gold Trust, or IAU listed on the NYSE Arca, posted the third strongest gain, adding 4.7 tonnes during the quarter and bringing its total assets to 79.3 tonnes. ETFS Physical Gold (listed on the London Stock Exchange) experienced net outflows of 11.2 tonnes during Q4, although it added 44.2 tonnes overall during 2009. GBS Bullion Securities (listed on the London Stock Exchange) shed 7.8 tonnes during the quarter, although it had a net gain of the same amount during the course of 2009.
- GLD options
Trading in GLD options more than doubled in the fourth quarter of 2009 to a total of 13.7 million contracts from 5.7 million in the third quarter, and it more than tripled from the same period last year as both call and put option transactions increased. Volumes sharply increased from an average 132,277 contracts per day in early October to a daily average of 353,521 contracts in the fi rst half of December, subsequently easing to 212,624 contracts, on average, by the end of the year, much in line with movements in the gold price. Call and put volumes peaked on 4 December at 252,897 and 474,108 contracts respectively. Whilst options volume generally rose as the price of gold increased, the peak coincided with the largest daily drop in the gold price during Q4, when the yellow metal fell by 3.8% to US$1161.4/oz from US$1207.6/oz the previous day. At-the-money implied volatilities traded in a range of 20.0% to 27.0% on the 3-month call and put options; implied volatility reached the low for the quarter on 30 October trading at 20.4%, increasing to 27.3% by 9 December, and fi nally retracing back to 23.0% by the end of the quarter.
- Gold futures
Comex total non-commercial and non-reportable net long positions, a proxy for the more speculative end of investment demand, remained strong. The net long position reached 28 million ounces by the end of Q4 compared to 27.5 million ounces at the end of Q3. On average, net long positions in Q4 increased by 27.0% from 22.9 million ounces on average in Q3. The net long peak of 30.8 million ounces in early December coincided with the historical high in the gold price of US$1212.50/oz on the London PM fix, on 2 December. By the end of the quarter, net long positions fell slightly to 27.9 million ounces, much in line with movements in the price of gold. Overall, netlong positions rose on the back of an increment of 29.0% in long-only positions from Q3, which was partially offset by a 42.0% surge in short-only contracts during the same period. Whilst net long positions increased on average during Q4, the rise was relatively tame compared to the increment in the gold price, as demand fl ows for gold were probably not primarily driven by speculative trading.
- Bars and coins
The latest available data on coin and bar sales corresponds to Q3 2009 (comprehensive Q4 data will be released in mid-February). Net retail demand for gold, which includes demand for coins, small bars, medals and imitation coins, and other retail investment, remained strong during the third quarter. It rose by 17.9 tonnes to 185.9 tonnes in Q3 2009 from 167.9 tonnes in the previous quarter, an increase of 10.7%. This largely reflects a recovery in investment demand in non-western gold markets, partly offset by a reduction in net inflows in western markets. The single biggest infl ow during the quarter occurred in China, followed closely by India, at 26.8 tonnes and 26.0 tonnes respectively. Whilst the third quarter was not as strong for the US, Q4 data on American Eagle bullion coin sales from the US Mint shows a more rosy picture. Demand for 1-ounce coins increased by more than 27% in the fourth quarter, on a quarter-on-quarter basis, and total demand for coins (including smaller denominations) rose by 66.0% relative to Q3 2009 and by 14.0% relative to Q4 2008, to a record 471,000 ounces (14.6 tonnes) during Q4 2009. Anecdotal evidence suggests a similar pattern in global coin demand.
- Lease rates
The implied gold lease rate is the difference between the dollar interest rate and the equivalent duration gold forward rate—the rate at which gold holders are willing to lend gold in exchange for dollars, also known as the swap rate. On the one hand, the 3-month US Libor rate remained very low at 0.25% during the quarter. On the other hand, the 3-month gold swap rate fell to a low of 0.27% by the end of October to later rise to 0.42% by mid-December as the gold price fell from its record highs in early December, and then back to 0.32% by the end of the quarter, as the gold price rose slightly again. Consequently, the implied gold lease rate remained modestly negative.
Market Influences and Outlook
The recovery in the global economy, especially in the countries like India and China, is likely to play a positive role in jewellery demand. However, jewellery was not a primary source of support for the price of gold in 2009. Investment flows, dollar-hedging, infl ation protection, and central bank buying all played a role in propelling the yellow metal to successive new highs.
Looking forward to 2010, a growing number of investors are worried about price stability. The large sums of money supply that reached the market in 2008 are creating concerns that inflationary pressures loom. Investors who do not believe higher inflation will materialize may still worry about the dollar outlook.
During our meetings and in surveys we conducted at conferences throughout the second half of 2009, we found that investors who hold gold, on average, have allocations of 5-7% in their portfolio. Yet, overall assets under management in gold remain low. As of Q3 2009, we estimate that only about 1.1% of global assets are invested in gold, compared to other alternative investments which correspond to about 4.4% of assets. There is, therefore, ample scope for growth.
For example, of those investors surveyed, almost half (45%) were planning to increase their gold exposure, and only 1 respondent was planning to reduce it. More than two-thirds of investors cited gold being an infl ation and dollar hedge as their primary reasons for holding the yellow metal, and about half used it for portfolio diversification. Less than a quarter of those investors were using gold as a vehicle to express a tactical view, in line with other signs that many of the investment fl ows into gold have tended to be more strategic in nature.
The fourth quarter of 2009 was an interesting one for the official sector. Separately, the pattern of behaviour among central banks continued its recently established trend, as sales under the third Central Bank Gold Agreement (CBGA3) slowed to a negligible rate, whilst banks and official sector institutions outside of the agreement clocked up another quarter of net purchases, according to our estimates
The most significant development of the quarter was the announcement by the Reserve Bank of India (RBI) that it had bought 200 tonnes of the IMF’s 403 tonnes of planned gold sales. The move boosted the RBI’s gold reserves to 558 tonnes and lifted the proportion of gold in total reserves to 6.4% from 4.0% prior to the sale. The RBI announcement was followed swiftly by the news that Sri Lanka’s central bank purchased 10 tonnes of gold from the IMF in a transaction that tripled its holdings of gold, which now stand at 15.3 tonnes and account for over 22% of total reserves. Finally, the Bank of Mauritius announced that it had purchased a further 2 tonnes, doubling the bank’s holdings to 3.9 tonnes.