Gold ETFs absorb more than $3 billion in first 24 trading days of 2009

With the gold price reaching records in a number of important consuming nations, jewellery demand is stagnant - but ETFs are soaring; are they establishing themselves as the west's answer to small bars?

LONDON - 

The markets' renewed belief since the start of this year in gold's role as a risk hedge has been made abundantly clear and nowhere more so than in the figures released for the Exchange Traded Funds.  These have been breaking records and making headlines on an almost daily basis and it is perfectly possible that this publicity has also aided gold's cause with a degree of self-fulfilling momentum.  In the whole of last year the total net dollar inflow into the major ETFs was $16.4 billion, while in the year to date, just 24 trading days, the major ETFs have taken up some $3.1 billion in the absorption of 111 tonnes of gold.  There has been only one day of net redemptions since the year began, and since the start of the year the amount of gold in these funds' vaults has increased from 1,121 tonnes to 1,231 tonnes. 

It is worth putting this into some perspective.  An uptake of 111 tonnes in just over one month compares with 316 tonnes in the whole of 2008, 250 tonnes in 2007 and 257 tonnes in 2006.  These funds tend to be dominated by retail investors and pension funds (they are particularly attractive to those pension funds whose charters do not allow them direct exposure to commodities) and these investors tend to be long term holders.  There is also an element of exposure from the hedge fund fraternity, and this latter would have been responsible for some, although by no means all, of the redemptions last year, which came in short bursts (see the charts below). 

Retail investors, especially in the United States, also have an affinity for coins and some western investors have been expressing a specific preference for coins even over the allocated metal in an ETF because they are concerned about counter party risk. The fact that, as a holder of an ETF the investor has an investment in allocated gold and is therefore effectively a secured creditor of the holding bank is carrying little water with some frightened investors and they have been choosing coins or small bars as their referred means of investment.  The US Mint has so far sold Gold Eagles containing 94,500 ounces of gold (2.9 tonnes), of which 92,000 ounces were sold in January. This may seem to be relatively small beer, but sales in January 2008 were just 26,000 ounces or 800 kilos, so US coin sales so far this year are running at 3.5 times as much as twelve months ago. 

On the speculative side of the market, the net speculative long position on COMEX, which does not involve physical gold, but which measures speculative sentiment, has increased from 444 tonnes at the end of last year to 493 tonnes in late January, a gain of 49 tonnes. This has comprised net purchases of 88 tonnes of longs, partially offset by 40 tonnes of fresh shorts. 

Figures from the World Gold Council (compiled by GFMS Ltd) show that investment bar demand in the first quarter of 2008 was 79 tonnes, and was as much as 232 tonnes in the third quarter of the year (full year figures are not yet available).  Jewellery is obviously a much larger market and in the first quarter of last year, world jewellery demand was 444 tonnes, rising to 624 tonnes in the third quarter of the year. The start of this year is a much less encouraging picture, however.  With gold at record highs in both rupees and Turkish lira, and with a worrying economic and financial environment, the gold jewellery market in these and other regions is suffering badly, and a lot of the demand this year, such as it is, has so far been furnished by recycled metal.  

While it is unlikely, even with jewellery struggling, that ETFs would ever compete with the jewellery market (different sizes, different investment rationale), this year's lively level of ETF demand is clearly competitive in tonnage terms with investment bars.  The question that arises is, will these funds reach critical mass or will they continue to attract investment from - inter alia - western individuals in the same way that kilo bars are consistently bought in the Middle East and Asia?  If ETFs start to be regarded in the west in the same way that small bars are regarded in Asia then there is every chance of more substantial inflows, quite apart from the activity from the pension funds.  This would be grist to the bulls' mill - but there are two sides of every coin and bears would be able to argue that the holdings in these funds might represent an all-too visible overhang once the financial and economic environment changes.

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