The Shifting Demand Forces in the Gold Market – A Resurgence of Traditional Physical Buying

Prepared by Ryan Case, Trading and Business Development, Bullion Capital Limited

With gold prices below US$1,400 we are seeing renewed interest from investors who are seeking exposure to gold in their portfolio but were not prepared to chase prices at record highs. This article looks at the various drivers of gold investment demand and highlights the movement from institutional investment back into traditional physical investment.

Historically, jewellery and physical bars have accounted for around 70 percent of total gold demand. However, Figure 1 shows that in 2009 these traditional mainstays accounted for only 35 percent of total demand. Although this traditional source of demand had halved in size in 2009 from historical levels, institutional demand from investment funds had increased dramatically and accounted for a massive 52 percent. While this decline in physical investment was replaced by institutional investment, gold was able to be propelled to all-time highs.

Figure 1: Total Gold Demand, 2009 Q1 and 2013 Q2.

Figure 1


In the first half of this year, traditional physical demand returned to the fore, replacing institutional investment, as the gold price fell from the high of US$1,696.20/oz in January to the low of US$1,180.57/oz in June. Net institutional investment turned negative, presumably as risk expectations changed, the US economy continued to show growth, and forecasts grew that the gold bull market may be coming to an end.  However, this net institutional disinvestment coincided with a resurgence of the traditional physical market, accounting for 73 percent of total demand Q2 in 2013. It was this strength in physical investment that eventually offset the selling by institutional investors and helped provide the price floor above US$1,180/oz at the end of June.

When speaking about the resurgence in physical demand, commentators talk about gold holdings moving out of weak hands – or speculative money – and into strong hands – the physical buyers who have historically accounted for the majority of demand. As seen in Figure 2, substantial sales from institutional investors translated to 456 tonnes of net disinvestment, while at the same time there was a 52 percent increase in physical bar investment.

Figure 2: Institutional Investment Demand vs. Physical Investment Demand.

Figure 2

In Figure 3, the rapidly declining COMEX warehouse inventories show how, following the rapid decline in gold prices, bullion has been withdrawn from New York at an unprecedented rate in order to satisfy physical demand. Considering India’s economic woes and China’s affiliation with gold, it is not surprising to see the majority of physical flows into these key consuming markets. A Bloomberg headline on August 20, 2013 reported that “U.K. Gold Shipments Climb Eightfold as Metal Seen Moving to Asia”, indicating flows out of London too. This shows an obvious divergence between the paper market, where bearish sentiment has prevailed, and the physical market, where demand for bars, coins and jewellery have surged, and highlight the shift in demand sources.

Figure 3: Bullion Has Been Withdrawn From New York At An Unprecedented Rate
(September 2008 – September 2013)

Figure 3

Following this period of net institutional disinvestment in bullion, it seems that the retail investor has returned to the gold market, helping to give the gold price some stability as bullion appeals once again to longer-term investors. The maintenance of accommodative monetary policy around the world could see renewed demand from institutional investors, which in turn could present the next upside driver for the gold price.

Prepared by Ryan Case | Trading and Business Development | Bullion Capital Limited

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Precious Metals Investment Symposium