Gold Price vs. Demand: ETFs & Central Banks


Gold has traditionally been viewed as a haven from political and financial uncertainty and as a hedge against inflation. During the period 2010-19, demand for gold products fluctuated significantly. Between Q2 of 2013 and Q1 of 2016, there was a 187% increase in demand for gold ETFs and similar products. Similarly, in 2010 central banks and other institutions had negative demand for gold, in Q3 of 2018 demand surged to 253.1 tonnes. Gold prices peaked in Q3 of 2011 and Q4 of 2012 but have since hovered around $1200-1300 over the last five years.

What does the Graph show?

The graph shows the demand for gold by central banks and other institutions as well as by investors through ETFs and similar products over the period 2010-19. Demand is measured in tonnes displayed on the left-hand y-axis.

ETFs & similar products include SPDR Gold Shares, iShares Gold Trust, and ZKB Gold ETF among others- data is reported by the product issuers. Centrals banks and other institutions are defined as ‘central banks and other official sector institutions, including supra-national entities such as the IMF’ per the World Gold Council.

The graph also tracks gold price in $US per Troy ounce over the same period. This is indicated on the right-hand y-axis which is labeled USD.

Why is the chart interesting?

Investors’ interest in gold-backed ETFs has fluctuated over the past decade, often reflecting economic uncertainty.

As shown in the chart, there was a significant rise in demand for ETFs and similar products in Q2 of 2010. One explanation for this was the beginning of the Euro sovereign debt crisis wherein several countries (including Portugal, Iceland, Greece, Spain, and Ireland) experienced collapsing financial institutions and high government debt. Investors turned to gold ETFs which are perceived as more secure stores of wealth. A similar situation occurred again in 2016 when demand for ETFs peaked at 374.1 tonnes. In this case, investors may have been reacting to the UK Brexit referendum and the shock election of Donald Trump in the US as well as the roll out of stimulus packages in Australia and Japan.

The gold holdings of central banks and other institutions also fluctuate for similar reasons. In a survey of 22 central banks by the World Gold Council (WGC), 76% cited gold being a safe-haven asset as highly relevant to their decision to invest in it. 59% also believed it was an effective means by which to diversify their portfolios. Since Q1 2018, central bank holdings of gold are up 165% to 224.4 tonnes. Furthermore, in the survey of banks none reported a desire to reduce exposure to gold, while 18% planned to increase their bullion holdings over the next 12 months.

Gold has also been used as a hedge against inflation. When inflation occurs weakening the US dollar relative to other currencies, many investors look to transition their money into hard assets such as gold, which they believe will better maintain its value. Selling their dollars for gold, however, drives down the value of the dollar which may further stimulate gold demand. Despite this, only 6% of the central banks surveyed cited ‘inflation hedge’ as ‘highly relevant’.

Conversely, what leads people to reduce their gold ETFs or central banks to reduce their holdings? Focusing on 2013, the large decrease in ETF demand was partially explained by wide-scale profit-taking. With gold reaching record-level prices in 2012 following the Euro sovereign debt crisis, many investors began to sell their positions. An investor who had purchased gold as a safe haven at the beginning of 2010 (when it cost $1109.12/oz), could sell for as much as $1721.79/oz at the end of 2012. Similarly in 2016, following three quarters of increasing demand for ETFs and rising gold prices, demand for ETFs went negative as the sell-off caused the price of gold to be driven down subsequently.

In addition, central banks might decrease gold reserves through trade export with the incentive that gold price increases can create a trade surplus that strengthens their currency. Therefore one risk to central banks of purchasing gold is becoming a net importer, which could ultimately devalue a country’s currency if it must print more money to fund its purchases or reduce holdings of its own currency.

Moving forwards demand for gold will be affected by potential global economic slowdown, the on-going US-China trade war and uncertainty surrounding future monetary policy of the US Federal Open Market Committee (FOMC).

The IMF made its lowest forecast of global growth since the financial crash in 2008-09. However, the implication of this for gold investors is mixed. While growth has slowed, it still remains above 2% buoyed by continued (although slower) growth in emerging markets such as China and India. Emerging markets comprise an ever greater share of the global economy than they did forty years ago.

Furthermore, economies have become more robust. Decreases in global manufacturing have been offset by stability in global services. Altogether, this is reason to say that slower global growth alone is not pushing investors towards gold. Rather, the US Federal Open Market Committee’s response to slower growth in the form of rate cuts has had more significant impacts.

With a fast-approaching potential third cut to the federal funds rate in 2019, investors may switch to gold because lower rates reduce the opportunity cost of holding non-yielding bullion. Lower rates can spur economic growth but may also lead to inflation. Uncertainty around future monetary policy has increased gold’s appeal, indeed from Q1 to Q2 of 2019 there was a 49.8% increase in demand for gold ETFs and similar products.

The US-China trade war continues to impact investors as the Chinese central bank increased its gold holdings for the sixth month in a row. One of China’s historical strategies has been devaluing its currency to undermine US tariffs. Increasing its gold backing may help provide further stability to its economy in the long-run, potentially providing scope to increase fiscal spending in the event of a recession, when Gold price typically rises. China’s decisive move towards gold may persuade investors to follow suit.

Interestingly, other precious metals have often tracked gold. Indeed, as gold prices have increased in 2019, so too have prices of platinum and palladium. The average price of platinum has increased nearly 10% since the year’s start with palladium also surging up 27.9%. Similarly, in 2013 when many investors exchanged gold holdings for profits (which drove the price of gold down), the prices of platinum and silver also decreased by 17.4% and 37% respectively.

One difference between gold and other precious metals is its lower price volatility when excluding periods of large movement by investors between fiat currencies and commodities. This is likely due to the stability of the supply of gold which renders even large trades unable to sway prices to any large extent. Indeed, production volume is small annually and costs are also stable. For example in 2010, 72 million troy ounces of gold were produced globally where the total amount of gold was 5 billion troy ounces, meaning that production was under 2% of the inventory. The gold inventory is further stabilised by the fact it is not used up as other metals are. The overwhelming majority of gold is held as jewelry, coin or bullion and any that is used in industry is often meticulously recycled, unlike palladium or copper.

Posted by Aimée Allam