Royal Bank of Canada Capital Markets analysts Dan Rollins in Toronto and Jonathan Guy in London have come up with a detailed analysis of the gold market over the next few years comparing it with the big ETF driven gold price rally of 2005-2008.

Over this period, gold doubled in price from $450 to $900, and while the analysts are not putting exact price predictions into their prognostications, nor coming up with a precise timescale, the implication is there in their research that this could lead to a big gold price increase in the medium to long term.

There is little doubt that the introduction of gold ETFs, and notably of the World Gold Council backed SPDR Gold Shares ETF (GLD) back in 2004, had a huge impact on the growth in the gold price up until its 2012 peak – and heavy sales out of the ETFs in 2013 were perhaps the principal cause of the gold price collapse that year.

While there may be doubts as to whether this kind of level of investment into the gold ETFs in the boom years is likely to be replicated, so far this year sales out of the ETFs appear to have started to be replaced by purchases, with GLD having put on around 22 tonnes of gold so far as against sales totalling 130 tonnes in the first 2 ½ months of 2013.  Quite a turnaround!

But, it is not the huge change in the ETF figures that the RBCCM analysts are looking to as the main driver to see the gold price rising in the medium to long term, nor the short term politico-economic implications of the Ukraine crisis, but what they see as the huge, and sustainable, rise in gold purchases by China, which they reckon as replacing the surge in ETF purchases which drove prices after 2005 up until the 2012 crash.  While they see similarities with the 2005-2008 period, the comparative figures could even suggest an even greater impact on the gold price. 

For example, between January 2005 and December 2008 GLD added 671 tonnes of gold.  Taking the net Hong Kong gold import figures alone, plus Chinese gold mine production, China appears to have absorbed just short of 1,600 tonnes of gold in 2013 alone – and the true figure is likely to be far higher given there are other routes for Chinese gold imports than just via Hong Kong.

Back in 2005, Chinese gold imports were negligible – so the difference here is enormous and is actually far bigger than the sales out of the ETFs.

Now some speculate that the recent rise in the gold price may dampen Chinese demand and that it is price sensitive.  The RBCCM analysts disagree suggesting that Chinese gold demand may actually be less price sensitive than that seen in India and the West.

They note that the level of Chinese savings has increased from 6,000 billion yuan at the beginning of 2000 to 47,000 billion yuan at the end of 2013 (approximately US$7.5 trillion) suggesting that Chinese households have the capacity to continue to buy gold jewellery and invest in gold and may choose to do the latter rather than holding all of their savings with Chinese banks.

They also note that Chinese gold imports via Hong Kong alone were an estimated 3% of Chinese household savings and 14-16% of urban savings and believe that this level of gold demand could remain stable or even continue to rise owing to continuing growth in the country’s GDP which they put at around 7% per annum currently.

Assuming the rate of gold purchasing remains stable, higher wages and increasing urbanisation should directly correlate with increasing gold demand. The Chinese have a huge propensity for saving and the ever growing middle class may increasing look for ‘hard asset’ savings options.

The analysts also see the likelihood of the Indian government pre or post the April general election relaxing the unpopular gold import taxes and restrictions and point to the big premiums of up to $150 per ounce that Indian buyers have been prepared to pay for gold in the past few months as the likelihood of pent up demand there – perhaps exploding should the restrictions be lifted.

They also see central bank buying of gold continuing, although perhaps at a reduced rate from that seen in 2012.  Initial figures this year suggest a further slowing down, or even a return to sales – but these figures are distorted by Turkey where ‘official’ gold holdings include gold held on deposit by the central bank for the country’s commercial banks, so the overall gold holding is much more subject to volatility.

There is also some speculation in the report on the level of Chinese gold holdings.  While these have officially remained unchanged at 1,054 tonnes for the past five years, there has remained strong speculation that China has been holding gold in separate accounts from that of the central bank and thus not declaring this to the IMF – as was seen in 2009 when the country suddenly announced a virtual doubling of its holdings.

The RBCCM analysts suggest that China probably now has gold reserves totalling 2,700 to 3,000 tonnes, although others believe the figure could be far higher.  However we won’t know the truth of this unless and until China announces any change in its official holdings – and even then we are only reliant on what China tells us they are.

RBCCM does see some ‘moderate’ risks ahead regarding its price analysis including the possibility of significant new IMF/central bank selling as part of the European Central Bank Gold Sales Agreement that is expected to be renewed upon the September 27th, 2014 expiry. Although it should be noted that the sales levels suggested in past Agreements have not been reached even when the banks were actually selling gold and they have been purchasers over the past couple of years.  They also see the possibility of central banks selling gold to mitigate domestic financial crises.

They also see the possibility of rising interest rates putting something of a damper on continuing gold price rises with the gold price showing a strong negative correlation with real interest rates historically.  For the moment the U.S Fed, the ECB and the Bank of England have been following a low to negative real interest rate policy, but there is the possibility that this could change gradually should the global economy make any real progress.

The analysis does not take account of anything that is happening in Ukraine at the moment as it was presumably prepared ahead of the current crisis blowing up. Gold has slipped back a little this morning given the hiatus following the referendum in Crimea which produced a huge majority in favour of independence from Ukraine and rejoining the Russian Federation.

But there is the prospect for the situation to escalate quite sharply with possible tit-for-tat sanctions being applied and even of military conflict between Ukraine and Russia which could blow up into something more serious, so that could be a major short term influence on the gold price.  If tensions ease the gold price could fall back sharply, but if matters do escalate then we could see gold moving substantially higher.

See: Russia/Ukraine escalation could drive gold to $1400 – or higher – short term