Going for gold: passive flows and price fluctuations

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).

“But increasingly, thanks to the growth of exchange traded products, the gold price is determined by the actions of financial traders and that appears to have exacerbated its volatility.”

ETP outflows

So it seems investors are gaining exposure to gold through passive products and that this has the potential to be a growing market. Analysis of the European ETP market by Morningstar for the first half of this year exposes a less positive trend, however.

While the European ETP market saw inflows of €22.9bn in the first six months of 2014, commodity and money market ETPs experienced “mild” net outflows during the period of €200m each. Morningstar identifies that gold, “safe haven and pricey products” also fell out of favour with investors in the first half of the year.

Jose Garcia-Zarate, senior ETF analyst at Morningstar, observes: “Where we have seen outflows this year, it’s notable that ETP investors are moving out of some of the popular but pricier ETPs.

“Given the eroding effect of costs on long-term investment returns, it is very encouraging to see that ETP investors are actively discriminating products in cost terms.”

Other factors could be behind the outflows recorded by the gold ETP market, as Chris Beauchamp, market analyst at IG Group, points out. He cites the increasing trend among investors to hunt for income as opposed to investing in what are regarded as ‘safe haven’ assets.

“Faced with an asset designed to provide safety in emergencies, and ones that provide a yield, most [investors] have sensibly chosen the latter, and outflows from gold ETPs confirm this,” he reasons.

Where is the price going?

The geopolitical tensions in Russia and Ukraine had been driving investors back into gold but the easing tensions in the region at the same time as a strengthening US dollar does not bode particularly well for the asset.

Nevertheless, Daniel Fisher, chief executive at Physical Gold, which provides gold bullion into UK self invested personal pensions, believes that gold has “found momentum”, which will continue into the second half of 2014.

He adds: “The Indian wedding season tends to push the gold price higher more often than not, so we expect third quarter demand from the sub-continent to combine with the macro elements to provide sustained price growth for precious metals enthusiasts.”

The outlook for gold and commodities certainly seems mixed but ETPs could provide an alternative way for investors to exploit these asset classes. Some of the negative news flow may also present a buying opportunity for some investors.

While passive strategies like ETFs and ETCs may not find a place in every investor’s portfolio, for others these products offer diversification. Certainly, the growth of gold ETFs suggests that they are finding favour among UK retail investors.