The gold ETF sector still shines

Gold has gained from the financial crisis and subsequent recession. Although inflows reversed over summer, the long term prognosis for the gold ETF sector is positive. Paul Burgin reports

In times of trouble, investors head for gold. Until 2004, buying into physical gold was a costly and complex business. The additional security worries about stashing gold in the basement did not help either. For retail and institutional investors, gold exchange-traded products (ETPs) have proved a boon throughout the financial crisis and recent sovereign worries in the eurozone.

Concern about Greece and the future of the euro caused the latest spikes in gold bullion prices. The World Gold Council (WGC) reported gold prices rose throughout the second quarter to end it at $1,244/oz on the London PM fix. The 11.5% gain on the first quarter was the best since early 2008.

The council’s latest Gold Investment Digest states: ‘While the price of gold has fallen to the $1,200.00/oz level in July trading, the trend remains well supported and gold’s performance is underpinned by the multiple factors that affect its demand and supply.’

It gives several reasons for the continued upward climb in gold prices in the first half of the year. Net inflows in to gold-backed investments remained strong. Credit woes in Europe impacted negatively on the outlook for both the euro and sterling. Investors also looked to gold as an alternative to the US dollar.

Gold worldwide

Investors around the world saw their gold holdings appreciate at different speeds throughout the second quarter as currency volatility remained in place. Euro investors saw prices rise by 23.1%, while sterling investors only saw gains of 13.2%. The yen’s strong appreciation hit returns for Japanese investors, who experienced amongst the worst returns over the quarter at just 5.7%.

Of particular note, the WGC saw over 270 tonnes of gold added to ETPs in the second quarter of the year. It says inflows were the second largest on record, bringing the total gold holding in ETPs to a new high of over 2,000 tonnes worth more than $80bn. 

SPDR Gold Shares (GLD) experienced the largest net inflows, adding almost 200 tonnes to a total of 1,320.4 tonnes at the end of the second quarter. GLD’s assets passed $50bn during that time as it benefited from the lion’s share of global ETF inflows.

When markets or sentiment reverse, GLD can also be one of the biggest losers. Assets slipped back below the $50bn mark as it experienced net outflows of $1.4bn in July, according to Morningstar data.

Overall, Morningstar says ETPs experienced net inflows of $9bn in the six months to the end of July, in line with the WGC’s findings. Most of that activity appears to have occurred in May and June, before investors pulled back in July.

ETF Securities has been one of the winners as demand has surged. ETFS Physical Gold added 30.8 tonnes of the metal to its holdings in the second quarter, out of a European total of 70 tonnes. It is now the world’s third largest gold ETP, according to Morningstar, although it remains just one tenth of the size of the SPDR Gold Shares vehicle.

Nicholas Brooks, head of research and investment strategy at ETF Securities, says recent times have been interesting for gold investors. He says: “In Q2 we saw the strongest flows into our physical-backed gold products, much more than in the financial crisis.”

Year-to-date, inflows to ETF Securities’ gold ETPs have totaled $2bn, with the physically-backed vehicle remaining the company’s biggest product by AUM. Investor concerns over the structural integrity of the euro were the main drivers of new money, rather than the typical search for assets likely to outperform Europe’s low interest rates.

Inflows came primarily from institutional investors, says Brooks. Pension funds and long only fund managers have sought out liquid gold vehicles for the sake of diversity. Many have been first time buyers.

US performance

Despite the relatively good performance of the US dollar, investors are still seeking an alternative to the currency. Brooks says: “Structurally, the dollar does not look so good. People were talking about its long term decline two years ago and are still concerned.”

Worries about the long term levels of individual currencies could also come to the fore over time. Having dived into the dollar, then the euro, investors are looking for another world-class bolt hole from volatility and uncertainty. Bric (Brazil, Russia, India and China) and emerging currencies do not quite have the caché nor stability yet, making gold an obvious default option.

In the short term, inflation is driving concerns about key reserve currencies, says Brooks. Longer term, demographics and how public debt is reduced could drive more investors into gold and ETPs. Brooks says: “Dependency ratios are rising and they have all taken on the problems of the banking sector. They need to work out how to deal with their still growing debts.”

Leading nations have three options, all of which are good for long term gold prices, says Brooks. The first choice is to simply default on debt, as Argentina did in 2002. Yet the country is only now being readmitted to world lending markets, and many G7 nations cannot take the risk of being frozen out for such a long period.

The second option is to tighten fiscal accounts, as many countries are now doing. Bringing primary accounts into surplus is a logical step, but politically it is extremely difficult, says Brooks. The third option is to take an opposite approach and simply print money. But with all that extra cash sloshing around the world’s currency systems, countries or trading blocks like the eurozone would find themselves quickly debased.

In any of these scenarios, gold is an obvious bolt hole. Brooks says: “The move to gold will continue until governments have proved they are doing the right thing. Prices will rise, but not necessarily in a straight line.”