Going for gold: passive flows and price fluctuations

This article is part of
Alternative Investments - September 2014

Investors may be familiar with the concept of investing in passive strategies such as exchange traded funds to get exposure to indices including the FTSE 100 and S&P 500. But passive products do not just provide UK retail investors with access to equities and fixed income.

The range and type of passive products on the market has become more sophisticated, with investors now able to access returns through ETFs, exchange-traded commodities or currency (ETCs) and exchange traded notes (ETNs), although this last product remains a small part of the market.

For those wanting to invest in commodities and gold, they can now do so through this wider range of exchange-traded products.

Moving the gold price

Gold has been experiencing a torrid time recently as investors have been reluctant to put their money into what is generally considered a defensive, ‘safe haven’ asset.

Global gold demand was 16 per cent lower at 964 tonnes in the second quarter of 2014 than a year earlier, as global jewellery demand, which represents more than half of total global gold demand, took a hit. Figures from the World Gold Council show demand for jewellery was down 30 per cent year on year in the period to 510 tonnes.

Total investment demand for gold, which includes investment in bars and coins combined with ETFs investment, paints a rosier picture: up 4 per cent in the second quarter of this year to 235 tonnes.

The World Gold Council states: “In the second quarter of 2014, many investors were uncertain about the direction and momentum of the gold price, while traders in price sensitive markets were far less active due to low volatility.

“The quarter did see an improvement in investor sentiment towards ETFs compared to last year. Outflows stood at 40 tonnes for the quarter, a tenth of the redemptions seen in the same quarter a year ago.”

It explains that the majority of these outflows occurred at the beginning of the quarter, and had turned to “marginal inflows” by the end of the period.

Gold supply is predicted to peak this year and then plateau over the next four to six quarters, according to the World Gold Council.

Jason Hollands, managing director of Bestinvest, claims physical gold prices have failed to “stage a convincing bounce back” so far this year. He acknowledges that one of the aspects of investing in gold that both advisers and investors struggle with is putting a value on this asset.

“While shares can be valued based on their profits or the attractiveness of their yield, the price of a lump of metal of limited real world utility is hard to value on a fundamental basis,” he says. Mr Hollands believes the growth in gold passive products has had an impact on its price.

He explains: “As a finite asset, the gold price is driven by demand and supply; it is ultimately worth what the next person is prepared to pay for it.

“Physical demand and supply can be influenced by factors such as industrial action in the mining industry, extraction costs, central banks dumping or building reserves, or factors such as the wedding season in India (the biggest market for physical gold).