What lies beneath the gold price slump?

This article is part of
Investing in Gold - May 2013

The biggest one-day drop in the gold price since the 1980s suggested more was at work than simply investors falling out of love with gold, or becoming a little more confident about the global environment.

Instead, it appeared to show the importance of momentum within gold markets.

The gold price has two main influences: physical buyers, buying gold bars or jewellery for a longer-term investment and investment buyers, who buy through exchange traded funds (ETFs) or futures and tend to be more short-term in nature.

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The most recent sell-off has been almost exclusively driven by ETF sales and activity in the futures market, hence its size and speed.

On the ETF side, Lipper fund-flow data showed global gold ETF ownership fell by $2.7bn (£1.7bn) for the week ended April 17, when gold experienced its most dramatic decline. Some of the world’s largest gold ETFs had significant outflows since the start of the year.

The SPDR Gold Shares ETF, for example, had outflows of nearly $13bn this year. Data from Bloomberg suggests that overall holdings in gold ETFs have fallen by 13 per cent this year. With the gold price falls, this has shaved $36bn from the aggregate value of gold ETFs.

However, Stephen Cohen, head of iShares EMEA investment strategy and insight, says there has also been activity in the futures market on the days when the gold price has fallen heavily, suggesting this has been an important influence.

Viktor Nossek, head of research at Boost ETP, says: “These big falls always tend to occur when gold reaches extreme valuations compared to other asset classes. Institutions with gold holdings instigate selling pressure, needing to sell to fund budget shortfalls. They sell by moving out of gold ETFs. This means that selling pressure tends to go on for a few days.” He says, for the time being, he is seeing continued selling in gold ETFs.

But recently the price has risen, albeit moderately. It is roughly 3.5 per cent higher for the week ended April 26.

In a recent note, Joni Teves, precious metals analyst at UBS, suggested Asia buyers had responded to the lower gold price with a wave of buying. The Financial Times reported that Hong Kong’s banks, jewellers and even its gold exchange had been left without enough gold supply to meet demand that was the highest in 30 years.

Mr Nossek says: “People have kept buying on the physical side, particularly now that it looks so cheap. In India, for example, people buy gold for weddings at this time of year. These buyers are not as price sensitive and will tend to hold gold for the long term.”

However, he says that these buyers do not create as much movement in the gold price as ETF buyers and sellers, which is why the gains have been relatively muted.

Mr Nossek believes that, for any sustained rise in the gold price, professional investors holding ETFs would have to step back into the market. However, they are more price sensitive and will be comparing gold to other ‘safe haven’ assets such as US Tips (Treasury Inflation-Protected Securities).