As ETF Investors Go For Gold, Is A Bubble Brewing?

By Glenn Dyer | More Articles by Glenn Dyer

As gold heads towards $US2,000 an ounce, it’s worth asking if gold is becoming a hostage of the Exchange Traded Funds (ETFs) that specialise in investing in the metal?

The half-yearly report on the gold market from the World Gold Council and the Refinitiv June quarter survey raises that question as both point to strong buying by ETFs.

In both reports, it is clear that apart from ETFs, demand for gold is being cut by its record high prices. If the gold market should stumble or equities sell-off in the face of the continuing rise in COVID-19 infections and deaths (and their impact on the global economies, especially the US), then the price of the metal (and silver) will drop.

That will force ETFs to start selling their metal holdings, which in turn will feed into a selling wave on Comex and other markets.

The World Gold Council (WGC) report illustrates the danger.

Second-quarter gold demand fell 11% year on year, pushing demand for the six months to June down 6%.

“The COVID-19 pandemic was again the main influence on the gold market in Q2, severely curtailing consumer demand while providing support for investment,” the Council said.

The Council says rate cuts and support spending and other moves from governments and central banks reacting to the pandemic “fuelled record flows of 734 tonnes into gold-backed ETFs (gold ETFs).”

“These flows helped lift the gold price, which gained 17% in US dollar terms over the first half, hitting record highs in many other currencies,“ the Council said, confirming that the reverse can happen if gold sells off or the slump in demand finally undermines momentum.

“Total bar and coin investment weakened sharply in Q2, leading to a 17% y-o-y decline in H1 demand to 396.7 tonnes,” the WGC said.

“This sector of investment saw a clear East/West divergence in investor behaviour, with most markets across Asia and the Middle East seeing a slowdown in investment, while Western investors increased demand.”

The first half saw a startling 46% slump in demand from the jewellery sector to 572 tonnes as markets remained in lockdown and consumers were deterred by the high price and a squeeze on disposable income.

Similar factors were behind a 13% fall in gold used in technology to 140 tonnes in H1, as end-user demand for electronics collapsed.

Central bank buying slowed again in the June quarter, although the comparison is with a June, 2019 quarter.

The sector added a net 233 tonnes of gold in the first half

The supply of gold was also impacted by the pandemic, falling 6% to 2,192 tonnes as both mine production and recycling were affected by lockdown restrictions.

Meanwhile, Refinitiv said the June quarter saw physical gold demand fall to 677 tonnes – its lowest levels since the March quarter of 2009 as record-high gold prices led to a drop in consumption.

Jewellery fabrication volumes, which typically account for around 55% of total physical demand, were again the worst hit segment by the pandemic, according to the Refinitiv research, with global offtake falling 53% in the second quarter, to a total of 240 tonnes, the lowest quarterly level seen over the past two decades.

“All the key regions witnessed severe losses as demand was paralysed due to the virus outbreak and lockdowns in many markets,“ the Refinitiv report pointed out.

The price of gold averaged $US1,711/oz in the second quarter, up by 8% from the previous three months and 31% above the level seen over the same period of last year.

“Notably higher gold prices, reaching record levels in many local currencies, put further pressure on demand,” the report said.

“Likewise, demand for gold used in industrial applications recorded a year-on-year decline of 16%, with losses across all the major segments. Official sector purchases dropped by 42% to an estimated 122 tonnes in the April to June period, largely caused by an absence of purchases by Russia and China.

Retail investment demand – which is the sum of bars and all coins – is estimated to have fallen 2% year-on-year to a total of 236 tonnes in the second quarter).

Refinitiv said physical bar investment was down by less than 1%, estimated at 169 tonnes, as poor performance in Asia was largely offset by a stellar demand in Europe and, to a lesser extent, North America.

“Gold bar demand in Asia slumped by 58% year-on-year, led by a sharp fall in India as a result of record-high gold prices and a national lockdown. Demand in China dropped by 2% year-on-year, hit by the economic slowdown and high gold prices.”

But it was a different story in Europe where “ old bar demand exploded”, led by its largest market Germany, driven by growing worries over the COVID-19 outbreak and its economic impact.

“Similarly, investment demand in North America jumped by 25% year-on-year.

“Coin demand, which is the sum of official coin fabrication and medals & imitation coins (MIC), slipped by 5% in the second quarter. This was led by a sharp fall in metals demand in India, which usually accounts for the bulk of gold demand from this sector, largely offset by a 27% rise in official coin fabrication.

Refinitiv said that after a strong first quarter, mine production is estimated to have dropped by 12% to 762 tonnes in the second quarter, with operations being affected by the COVID-19 outbreak.

“The most impacted regions include Latin America and Africa, which after strict lockdowns were placed on a non-essential activity, including mining in most cases.

“South Africa, Indonesia, Peru, and Argentina suffered heavy losses, while moderate gains were reported in Russia and Australia, mainly emphasising governments’ different approaches to the pandemic.

“Not only primary gold production dropped considerably during this period, but also gold as a by-product, especially from copper, silver and PGM mines were also dramatically affected.

“According to our records, nearly 130 mines had to be put under care and maintenance or continued to operate under reduced capacity.

“While restrictions in several countries have been easing during the last few weeks, with mines starting to ramp up production, due to heightened uncertainty many companies remain cautious, and have already withdrawn their guidance production,” Refinitiv said.

According to Refinitiv there was a surprise – a 7% year-on-year drop in scrap supply despite gold’s strong price performance.

But that fall came from reduced flows in the three largest markets, Asia, Europe and North America, which together account for nearly 90% of global scrap supply.

“Lower scrap volumes were due to disruptions and shutdowns caused by the COVID-19 outbreak, which saw scrap collecting agencies as well as refineries in many markets shut down for a few weeks, and thereafter operate at reduced capacities after re-opening,” Refinitiv pointed out.

Glenn Dyer

About Glenn Dyer

Glenn Dyer has been a finance journalist and TV producer for more than 40 years. He has worked at Maxwell Newton Publications, Queensland Newspapers, AAP, The Australian Financial Review, The Nine Network and Crikey.

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