Global holdings of gold-backed ETFs grew by just 18.9t in Q3: total AUM at end-September was 2,343.2t (US$96.7bn) – the highest since October last year. The sector saw outflows in July, before modest inflows resumed in August and gained momentum in September. But inflows into these products continued to lag well behind 2016’s record levels. During the Q1 to Q3 period, inflows of 179.7t were just one-quarter of the record inflows seen in the first nine months of 2016.
ETF investors lacked a clear catalyst in Q3 as the gold market was pulled in different directions, culminating in modest global inflows for the quarter.
The geopolitical environment continued to fan the flames of gold’s investment case. The increasing war of words between North Korea and the US – with its threat of nuclear conflict – was high on investors’ radars. US-listed funds added around 90t during August and September (offsetting July outflows of around 60t). And our market contacts reported that each escalation in tension led to a small but discernible jump in holdings of German-listed ETFs. Brexit and terrorist-related incidents also continued to reinforce investor interest.
Monetary policy, meanwhile, was more of a mixed blessing for ETFs. For the first two months of the quarter, the probability of a December US rate hike fell steadily. But this reversed sharply in September after the Federal Reserve signalled strongly that rates would rise in December. These shifts in expectations were reflected closely in the gold price, which traded in a broad upward range throughout July and August before swiftly retracing half of those gains in September.
Gold price moves were similarly mixed in their impact on ETF flows. The fact that the gold price held within the recent broad US$1,200-1,300/oz. range for much of the quarter encouraged some price-related tactical trading. Western investors were reported to have taken profits on their holdings as the price rose in July and August, before re-investing at lower prices at the end of the quarter. Notably, our contacts specified that investors were not taking outright short positions, but were rather liquidating existing positions to realise gains.
Soaring stock markets also played a dual role: investors used their gold holdings to balance their burgeoning equity positions. Investors the world over were reluctant to bet against stock markets – some of which reached new highs – and this tamed inflows into gold-backed ETFs. However, many used their strategic holdings of these ETFs to complement their equity positions as a hedge against any possible downturn.
Having led inflows into ETFs over the first half of the year, European investors relinquished their lead in Q3. ETFs listed in Europe saw small outflows of 6.8t during the quarter, in contrast to US-listed funds whose holdings grew by 30.4t. Year-to-date however, European-listed funds account for 70% of net ETF inflows, the bulk in German-listed funds.
ETF holdings in China dropped again in Q3, although the pace of decline slowed markedly. Net outflows of 2.9t reduced holdings in Chinese gold-backed ETFs to 42t at the end of September. Reports suggest that the flows were price-driven, with investors in the sector often buying after a price correction in contrast to the more traditional approach of buying into a price rally.
Bar and coin
Q3 global bar and coin demand shot up 17% y-o-y, reaching 222.3t (US$9.1bn). But the y-o-y comparison flatters to deceive: Q3 last year was the lowest level of bar and coin demand since Q1 2009. When considered in the broader perspective, Q3 2017 bar and coin demand was below its 3-, 5- and 10-year quarterly averages.
China made the biggest contribution to global y-o-y growth, with demand up 57%, reaching 64.3t. China’s gold market is in relatively good shape: y-t-d, 2017 has seen the second highest volume of bar and coin demand on record.1
Two themes have underpinned China’s market this year. First, from a macroeconomic perspective, fears over a potential depreciation of the yuan and the spectre of rising inflation continued to hang over investors. Second, there are relatively few alternative investment opportunities. The Chinese government, for example, imposed restrictions on the real estate market earlier this year. Gold, as a globally traded asset and a natural hedge against currency weakness, has benefited.
Competition in this market remains fierce. As noted in previous quarters, high-net-worth individuals increasingly prefer Shanghai Gold Exchange bars compared to commercial banks’ own products because of their lower premiums. In response, some banks have teamed up with renowned gold jewellers to build on each other’s strengths. In July, the Bank of Communications (BOCOM) partnered with Beijings Caibai – one of the largest players in China’s jewellery market – to develop gold investment products. Caibai brings skills in product design and manufacturing while BOCOM offers a vast network of branches and investment expertise.
In contrast, India – the world’s second largest bar and coin market – was weak. Demand fell 23% to 31t. As explained in the jewellery section, India’s gold market was once again beset by regulatory and tax changes – namely the PMLA and GST – which crimped retail investor activity.
GST also affected India’s trade flows. Bullion imports started on a slow note in July as importers struggled to adapt to the new tax regime, particularly around the process for obtaining a refund of GST paid by the bank and its impact on their cashflows. In the absence of clarity, most banks stopped importing gold on a consignment basis.
In another twist, the Indian market was awash with South Korean gold. For a while, traders took advantage of the free trade agreement between the two countries which stipulated that gold coins would be subject to only a 1% tax. The government closed the loophole following an outcry from the gold industry. But during the brief window of July and August, a total of 30t of South Korean gold coins entered the market. These were melted down for processing by jewellery manufacturers rather than sold directly to retail investors.
This flow from South Korea impacted on India’s domestic gold price: cheap imports pushed the local gold price to a discount of as much as $7/oz in August. Once the loophole was closed on 25th August, the discount narrowed and the local gold price moved back to a small premium by Diwali in October. The government also acted against trading houses that had imported the South Korean coins: on 18th October, the Directorate General of Foreign Trade imposed restrictions preventing them from selling imported gold in the domestic market.
Turkey recorded another impressive quarter. Bar and coin demand hit 15t, almost three times higher than the same period last year. A couple of dips in the lira gold price during the quarter proved tempting for some investors, but two themes have had a greater impact. President Ergodan’s pro-gold comments in November last year continued to lend support to the market. In addition, the government’s Credit Guarantee Fund – which guarantees loans to small and medium-sized enterprises that could not otherwise get credit – has boosted the economy and supported gold demand. Turkish gold demand was at its highest since 2013 on a y-t-d basis.
Bar and coin demand in Europe rose 12t to 45.5t, a 36% improvement on the relatively weak Q3 last year. Germany – the mainstay of European demand2 – made the biggest contribution, with demand up 45% to 25.1t. July saw a spurt of activity as the euro-denominated gold price dipped to its lowest level since February 2016. Geopolitical risk stemming from national polls has boosted demand in some countries in recent years, but that wasn’t the case in Germany. Contacts in the industry described the German election in September as a non-event, with minimal impact on gold demand.
Although a small market, South Korea saw an upsurge in activity. Investment demand jumped 42% to 1.4t against a backdrop of heightened tensions between its neighbour, North Korea, and the US. Sales of small gold bars – 100g and 10g – were strong, as investors bought an asset that is light enough to carry and to cash in.
The US market was depressed, with demand of 7.3t compared to 17.7t in Q3 2016. After a very strong showing in 2016 – the third best year for bar and coin demand on record in the US – 2017 has been rather unexciting: y-t-d demand was at its lowest level since 2007. Dealers report that investors are disappointed by the range-bound gold price, which compares poorly to the headline grabbing performance of the S&P500.