We have previously commented on a peculiar divergence observable among gold investors: whereas those who buy physical gold tend to buy more the lower the price of gold drops (as conventional economic theory says they should), the subset of gold-buyers who prefer to trade a "paper" version of gold in the form of ETFs only start buying when prices rise, with buying - ironically - peaking just around the time the price of the commodity does the same. Whether this has to do with momentum-chasing algos or is simply a travesty of what new normal "investing" is all about, is unknown, but what we do know is that as of this moment, global gold holdings in ETFs topped 2,000 metric tons for the first time since June 2013 following the Brexit fallout, when gold buying has sparked even more gold buying.
What is also curious is how much greater the impact of paper-denominated gold purchases on the price of gold is compared to simple physical purchases, which have been ongoing for the past year with barely a dent in the price of gold which had traded around $1,100 for nearly a year before it ultimately set off for its latest torrid ramp higher.
As Bloomberg notes, holdings in bullion-backed exchange-traded funds rose 4.1 tons to 2,001.4 tons on Wednesday, data compiled by Bloomberg show. That’s larger than the alleged gold reserves held by China (in reality China holds far more gold but it willing to only represent a fraction of its official holdings) the biggest consumer and a consistent central-bank buyer in recent months. The latest increase followed the biggest one-day gain since 2009 in the SPDR Gold Shares, the largest gold ETF.
Global assets in the funds have surged 37 percent this year and prices are near a two-year high as slowing growth, negative rates in Europe and Japan and the likelihood that the Federal Reserve won’t hike further combined to boost demand. The U.K.’s vote last month to quit the European Union has added further impetus to that pro-bullion mix. Gold has likely entered the early stages of the next bull run, according to UBS Group AG, while ABN Amro Group NV says prices may hit $1,425 this quarter.
“Investment demand has been very strong, with institutional buyers of ETFs the big gorilla in the room,” said John Butler, a vice president at GoldMoney, which provides custodian and investment services in Toronto. “We’ve reached a psychological tipping point where people see a material increase in the risk of a repeat of what we saw in 2008.” Client demand has been so strong recently that GoldMoney has struggled to keep up, he said.
Putting combined ETF holdings in perspective, the 2,000+ tons compare with the 1,808.3 tons held by China according to the WFC, even if that "official" number is fundamentally very flawed. They’re also about twice the size of Switzerland’s holdings and a quarter of the stash kept by the U.S.
The fundamental reason for gold's second renaissance is simple: the Fed is losing confidence in its need to tighten any time soon as officials face rising uncertainty about the outlook for growth at home and abroad. In Europe, there’s speculation policy makers may add to stimulus, as well as mounting concern about weakness in Italy’s banking industry. Finally, with negative rates becoming a global phenomenon, gold's zero nominal yield actually makes it a better "investment" than "safe paper" issued by many developed countries which now has negative nominal yield.
“The emergence of central banks collectively being more inclined to possibly deepen QE programs, including the Fed neutrality stand, have been a very good tailwind for gold,” said David Lennox, a resource analyst at Fat Prophets in Sydney.
More troubling, bank analysts have been raising forecasts as gold rallied. UBS increased its short-term target to $1,400 an ounce from $1,250, according to a July 5 note. Singapore-based Oversea-Chinese Banking Corp. has also flagged the potential for bullion rising to $1,400, while Goldman Sachs Group Inc. boosted its three-, six- and 12-month targets. In a July 6 note, ABN Amro’s Georgette Boele raised her end-of-quarter forecast by $75 to $1,425.
This means that while gold may continue to rise sharply in the coming weeks, it is only a matter of time before a dramatic repricing hit takes place as in September 2011 when the BIS actively intervened to slam the yellow metal far lower and break any upside momentum it had at the time, just as it was set to cross above $2,000. Once the momentum is gone, so will the algo (and Chinese) buying, which ultimately will be good news for those buyers of physical who would rather pay less than more in exchange for rapidly devaluaing paper money.