Financials, not fundamentals, drive gold

Gold hits another new seven year high; the COVID-19 crisis has had a profound effect on nearly every aspect of physical demand for gold.
  • Gold and gold stocks trend higher in June amid the US Federal Reserve’s continued preference to keep interest rates low
  • A new wave of coronavirus outbreaks is hindering economic recovery and lifting gold prices
  • While the physical markets, where demand for gold is weak, are important, they are secondary to financial markets as a price driver and demand there remains strong

Gold continues to trend higher in June

Gold and gold stocks shrugged off a weak start to end higher in June. The US Federal Reserve’s (Fed) continued preference to maintain low rates and expectations of a weak job market buoyed the gold market. Spot gold ended the month with a gain of US$50.69 (2.3%) per ounce to a new seven-year high of US$1,780.96 amid new coronavirus outbreaks in Beijing, Latin America and several states in the US. It is clear that the pandemic is becoming a persistent impediment to the economic recovery. Gold stocks rose with gold, with the NYSE Arca Gold Miners Index gaining 6.4%.

A unique financial asset, not a commodity

The gold market is unique for a variety of reasons. Gold has been a store of wealth throughout human history. It has functioned as a currency and remains an important component of central bank reserves. It acts as a hedge against systemic financial risks. For these reasons, we don’t see gold as a commodity, but as a financial asset.

Gold is hoarded like other financial assets such as stocks, bonds or even art. All of the gold ever mined is available to the market at a price. According to the World Gold Council (WGC), the above-ground stock of gold in 2018 was 194,112 tonnes (6.2 billion ounces). In 2019 there was 3,480 tonnes (112 million ounces) of gold added to the above-ground stock from mining, which translates to a supply increase of 1.8%. This limited supply that has grown at roughly 2% per year throughout history is a key reason that gold has functioned as a currency, store of wealth and inflation hedge.

As a financial asset, the price is driven by currency and interest rate movements, government policies and threats to the financial system. The price is determined in the financial markets centered in London, New York and to a lesser degree, Shanghai or Tokyo where the vast majority of trading volume takes place. A much smaller volume of trading occurs in the physical markets for bars, coins, jewellery, recycled scrap and mined gold. While the physical markets are important, they are secondary to financial markets as a price driver.

COVID 19’s effect on physical demand for gold

According to the WGC, global physical gold demand totalled 4,384 tonnes in 2019. Jewellery accounted for 49%, bars and coins 20%, central banks 15%, bullion ETF’s 9% and industrial uses 7%. These percentages will look different in 2020 as the COVID-19 crisis has had a profound effect on nearly every aspect of physical demand for gold. Here is our assessment:

China and India –These two countries are by far the largest consumers of gold, accounting for 1,539 tons or 35% of global physical demand in 2019. Lockdowns and the shutting of business have decimated demand in both countries. According to the WGC, first quarter global jewellery offtake fell to the lowest level on record, due to sharp declines in India (41%) and China (65%).

China’s Gold Association reported that total consumption fell to 148.6 tonnes in the first quarter, down from 308.3 tonnes a year ago. In India, gold imports slumped to 1.4 tons in May, compared to 133.6 tons a year ago. Bloomberg forecasts Indian jewellery demand will decline by 210 tons (30%) in 2020, while local market participants estimate a 50% (350 ton) decline in total consumption for the year.

Central Banks – The last two years were the strongest on record, as central banks had net purchases of 656 tons in 2018 and 648 tons in 2019. According to the WGC, approximately 40% of 2018 and 2019 demand was from Russia and China. First-quarter demand remained strong, with net purchases estimated at 145 tons. However, as the pandemic spread, many central banks turned their attention away from gold. The Wall Street Journal reported that in March, emerging markets countries depleted their foreign exchange reserves at the fastest pace since the financial crisis to contain a plunge to their currencies. UBS reckoned that central banks bought 26% less gold in April than the previous year, while Standard Chartered sees net purchases dropping to 360 tons in 2020. This is due, in large part, to China, which hasn’t increased its official gold reserves since October, and Russia’s decision to suspend gold purchases in April.

Fundamentally, central banks remain positive towards gold, suggesting that once the pandemic clears, many may step-up their purchases. A recent WGC survey found that 20% of central bank respondents plan to add gold this year, compared to just 8% in the 2019 survey. Some 75% expect global central bank reserves to increase over the next 12 months, compared to just 54% in 2019

Swiss Flows/Comex – Switzerland serves as the global crossroad for physical gold. Much of the gold that moves between London and the rest of the world makes a pit stop in Switzerland, where refineries recast the gold into the size, shape and purity needed in the local market of its destination. The overall volume of Swiss flows have been normal so far this year. However, the pandemic has radically altered the destinations of Swiss exports. The US overtook China to become the largest destination of Swiss exports this year. According to Metals Focus and Reuters, the US only accounted for 1% (around 15 tons/year) of Swiss exports from 2014 – 2019. This changed from March through May this year, with the US importing 281 tons from Switzerland. Meanwhile, China, Hong Kong and India combined imported just eight tons of Swiss gold over the two-month period.

The spike in Swiss exports to the US was caused mainly by gold flows into Comex warehouses. Because of lockdowns, transporting and refining bullion between London and the rest of the world became difficult. Hedging operations of bullion banks could not function normally and prices diverged between the two largest trading centres. Futures on New York’s Comex traded at premiums of as much as US$75 per ounce to the London spot OTC market. As a result, BMO Capital Markets’ figures showed that Comex inventories have more than tripled since March to 964 tons.

Swiss exports to the US and unprecedented Comex demand is related to logistics and trading arbitrage rather than fundamental factors. As such, much of this gold will eventually need a new home. Perhaps as the pandemic fades and other physical demand drivers normalise, Comex warehouse gold will find its way to other parts of the world.

Bars and coins – The economic damage caused by the pandemic, along with growing financial risks, have created very strong demand for bars and coins.  Retail investors dominate the coin market. Global mints have limited capacity and are unable to satisfy periods of heavy demand. As such, coins can trade at a premium to the spot price for physical gold. Premiums have soared to as much as US$135 per ounce this year.

Bullion ETFs are probably the largest force in the market for gold bars. Most ETF holders are institutional investors, while a lesser portion are retail investors. According to Bloomberg data, ETFs globally have added 622 tons to their hoard this year, which is already exceeds any full calendar year period since gold ETFs have been in existence.


Demand for jewellery, the largest component of physical demand, usually declines when the gold price is rising. Record gold prices in many local currencies, combined with pandemic lockdowns, have created unprecedented declines in jewellery demand. Central bank demand has also weakened this year. WGC data showed physical supply exceeding demand in 2019, yet the gold price rose 18%. It looks like 2020 might be another year of surplus for physical gold. Prices can rise if demand in the financial markets is robustg. Strong bullion ETF and coin demand gives us a window into the psychology of the financial markets, which have the most influence on the price of gold.

The above ground stock totals around 198,000 tonnes and the vast majority of owners are happy to keep their gold at current prices. In a bull market when financial markets are buying gold to hedge against risks, differences between supply and demand in the 4,400 tonne per year physical markets amount to an insignificant rounding error.

Published: 06 July 2020


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