ETFs Are Setting Gold Prices Now

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ETFs Are Setting Gold Prices Now

Two Data items today:

Topic #1: The World Gold Council was out last week with its Q3 2020 industry review. Three points of interest:

First, gold demand fell to 892 tons last quarter, down 12 percent from Q2 (1016 tons) and 18 percent lower than Q1 (1,084 tons).

  • Unsurprisingly, jewelry demand was weak at 333 tons, down 29 pct below Q3 2019 which the WGC characterized as already “anemic”. Even still, this category showed a rebound from the average demand for 1H 2020 of just 286 tons/quarter.
  • Demand for gold coins/bars was robust in Q3 at 222 tons, up 12 percent from 1H 2020’s average demand of 198 tons/quarter. The WGC noted that “Much of the growth was in official coins, due to strong safe-haven demand in Western markets and Turkey, where coins are the more prevalent form of gold investment.”
  • Gold ETFs (most of which must buy gold-delivery bars with incremental inflows) saw further fresh investment, with 273 tons of fresh demand. This has slowed, however, than the 1H quarterly average of 365 tons.
  • Demand for gold used in technology products increased to 77 tons from a 1H average of 70 tons/quarter.

Second, central banks were net sellers of gold for the first time in almost a decade (Q4 2010).

  • The WGC noted that the central banks of Uzbekistan and Turkey were responsible for flipping global CBs from net purchasers to sellers.
  • In total, global central banks sold 12 tons of gold in Q3 as compared to average purchases of 117 tons/quarter in 1H 2020.

Lastly, gold production actually fell 3 percent year-over-year in Q3 2020 to 1,224 tons but this is still 12 percent higher than the 1H 2020 average of 1,096 tons/quarter.

Our investment take on this data in 3 points:

#1: Bad news: Gold supply was 37% higher than demand in Q3 2020 (1,224 tons vs. 892 tons). Mining production and recycling have bounced back more quickly from Q2 lockdowns than global demand for jewelry has.

We assume this will continue to be the case unless large gold producing countries (China, Russia, Australia, the US and Canada are the top 5) curtail industrial activities during another round of virus lockdowns.

#2: Good news: for the first time ever, in 2020 ETFs have replaced jewelry as the largest source of global gold demand. There is a chart in the links below in case you want to see the progression back to 2009, but the basics are as follows:

  • In 2019, for example, jewelry demand was 4x ETF demand for physical gold (1,533 tons vs. 375 tons) through the first 3 quarters of the year.
  • For 2020 YTD, jewelry demand is 0.9x ETF demand (904 tons vs. 1,003 tons).

#3: That likely makes ETF/investment demand the swing factor for gold prices over the next 12-18 months. Jewelry demand will be slow to recover while investment demand can trend higher or lower and is now large enough to be the marginal piece of the gold price “pie” to set prices.

To visualize this trend, here is a WGC chart that breaks down sources of demand over the last 12 years through the first 3 quarters of each period; we’ve highlighted the ETF portion (in dark purple) to make it easier to see:

The worrisome point for gold is that 2013 saw 700 tons of ETF redemptions (that dark purple bar below the line), which highlights how volatile this source of demand can be.

Takeaway: we still like gold for its non-correlated hedging properties versus equities, something that has not changed even in 2020 as investment demand has become so important for the yellow metal.

Topic #2: Even as US 10-year Treasuries yields rose last month, let’s remember that across most of the developed world long term yields are 1) still much lower than the US and 2) generally declining:

  • 10 Year US Treasuries: 0.68 percent on September 30th, 0.84 pct now
    16 basis points higher last month
  • German 10-year bunds: -0.52 percent on 9/30, -0.63 pct now
    11 basis points lower last month
  • United Kingdom 10-year gilts: 0.23 pct on 9/30, 0.26 pct now
    3 basis points higher last month
  • Italian 10-years: 0.87 pct on 9/30, 0.72 pct now
    15 basis points lower last month
  • France 10-years: 0.24 pct on 9/30, -0.34 pct now
    10 basis points lower last month
  • Japan 10-years: 0.02 percent on 9/30, 0.04 pct now
    2 basis points higher last month

Takeaway: even as 10-year Treasury yields rose 16 basis points in October, average developed economy sovereign debt yields declined by 6 basis points over the same period. This highlights just how differently capital markets view US government debt just now, based on what we assume are concerns over large scale issuance in the coming weeks/months to fund virus-related fiscal stimulus.

Sources:

World Gold Council Q3 report: https://www.gold.org/goldhub/research/gold-demand-trends/gold-demand-trends-q3-2020