Gold Demand Trends Q2 2017

ETFs

Investors continued to buy gold-backed ETFs in Q2: global AUM grew by 56t. By the end of June, holdings of ETFs had reached 2,313t (worth US$92.4bn), the highest month-end total since October last year. H1 holdings were up by 167.9t. And while this pales in comparison with last year’s record growth, it nonetheless signals a continued interest in gold investment among institutional investors.

After 10 months of unhindered inflows in 2016, investment in gold-backed ETFs during the first half of 2017 have been rather more erratic. Of the main – sometimes conflicting – factors that influenced investor attitudes towards gold-backed ETFs, the three that seemed to dominate Q2 were:

• Monetary policy ‘normalisation’
• Gold price
• Event risk

Monetary policy was again front of mind during the quarter as the Federal Reserve raised rates in June and ECB President Draghi signalled possible tightening in Europe as deflationary pressures start to reverse. The prospect of continued, if modest, monetary tightening dampened ETF demand. Rising interest rates are usually interpreted as being negative for gold. But the Federal Reserve continues to telegraph its plans for monetary policy clearly, and – since the end of Q2 – market expectations of a third US rate hike have subsequently been pushed out to Q1 2018. This gives investors ample time to adjust positioning, so we believe that gold should not come under undue pressure as the timing of a likely rate rise approaches.

The gold price rose by 8% during the first half of 2017, building on the 8% gains seen during 2016. This led to some investors taking a more cautious approach, reluctant to build positions after a strong price move. Others used it as an opportunity to take profits. Although lower prices may encourage fresh buying, anecdotal reports suggest that investment in Q2 was not generally driven by investors’ expectations of strong near-term capital appreciation.

Event risk, particularly surrounding geopolitical tension, remained a key driver of demand for ETFs. Across Western markets investors were attracted by gold’s properties as an insurance asset. The environment created by sporadic global terrorist incidents, tension between the US and North Korea, and the shock sacking of FBI Director Comey, left investors keenly aware of the risk of unexpected, destabilising events, and this underpinned an element of gold-backed ETF inflows.

Investment in the US and Europe was quite evenly matched in Q2, with inflows of 30.9t and 35.2t respectively. But it is European investors who dominate the H1 picture: ETFs listed in the region grew by 128t in the first half of 2017, absorbing 76% of net global inflows. 

After a strong Q1, those inflows slowed markedly in Q2, although demand on the continent was firm, with little interest in outright selling. The region’s geopolitical climate settled somewhat after the election of French President Macron. Negative bond yields in Germany – home to the largest European-based fund, Xetra-Gold – continued to drive investment into domestic funds, albeit to a lesser extent than in Q1, as they recovered from the record lows seen in March. Anxiety caused by the UK election was largely confined to the domestic market, where Source Physical Gold ETF saw the biggest increase in holdings. The bulk of the 12.2t inflow was concentrated at the end of June, coinciding with the sharp drop in the Sterling gold price.

AUM in European-listed funds have grown sharply over the last 18 months. Tonnage grew from 570.2t at end-2015 to a new all-time high of 977.7t at the end of Q2, exceeding the previous peak of 960.1t from 2012.

Demand for US-based ETFs fluctuated throughout the quarter: inflows in April and June were partly offset by small mid-quarter outflows. Investors remained broadly – if inconsistently – positive in their approach to ETFs, as the factors outlined above vied for attention. Inflows of 30.9t were the strongest since Q2 last year. 

The path of inflation and interest rates continues to be subject to some uncertainty, with Federal Reserve messaging appearing to soften in recent weeks. Investors will continue to scrutinise the progress of the US economy, inflation and the US dollar, for signs that interest rate hikes may be pushed further out.

Away from the dominant Western markets, Chinese ETFs again saw outflows. Holdings of these funds dropped by almost 9t, more than half of which came from the Hua’an Yifu Gold Fund, which saw its first quarterly decline. Holdings dropped by 4.8t during the quarter, to 20t at the end of June – the lowest level for a year. But the outflows have reportedly had a positive consequence: strategic long-term investors now account for a greater share of the holdings in the fund. 

Chinese gold-backed ETF holdings have shrunk this year, having risen more than six-fold during 2016. This volatility in part reflects the speculative investment behaviour that is more prominent in China than in many other markets. Our consumer research confirms this ‘speculative’ bias, which is more closely linked to gold-backed ETFs than gold bars and coins. According to our research, 54% of Chinese investors described the role of their investment in gold-backed ETFs as being either speculative or for short term returns, compared with just 25% of investors in gold bars and coins.

Bar and coin

Bar and coin demand in Q2 rose 13% compared to the same period last year. The H1 performance was strong too, with demand up 11%.  Although encouraging to see demand bounce, the figures are flattered somewhat by exceptionally weak demand in H1 2016. When the longer-term trend is considered, Q2 demand of 240.8t was below both the five-year and three-year quarterly averages of 306.1t and 263t respectively.

In China, bar and coin demand increased 56% y-o-y, reaching 62.6t. This was a solid quarter, broadly in line with the three- and five-year average quarterly demand of 62.9t and 69.5t respectively. But when we look at recent trends it is clear that Chinese retail investment has slowed down a little. China saw exceptionally strong demand in the final quarter of 2016 and the first quarter of 2017, with over 100t bought in each. A depreciating currency and fears over State-imposed restrictions on the property markets in Tier 1 and 2 cities fuelled demand for gold as a high-quality liquid asset.¹ So far in 2017, however, the yuan has stabilised and the property market regulations have not had the impact many investors had feared.

Purchases made directly from the SGE continued to gain traction, accounting for a significant proportion of Q2 bar and coin demand. Investors benefit from better pricing – bars from the SGE are usually 5-10 yuan per gram lower than those bought from commercial banks – and a sense of security from knowing they are buying gold from a trusted provider. With a minimum lot size of 100 grams, direct withdrawals from the SGE largely serve China’s high net worth individuals.

Interesting things are afoot in Vietnam. Q2 2017 was flat y-o-y, with a modest 8.9t purchased. Real estate and equities proved far more interesting for many investors. But, as set out in its recently-distributed Circular No.03/2017, the Government is introducing measures to lift much of the red tape on gold bar trading activities.² From 22 July 2017, the Ho Chi Minh City and Hanoi branches of the State Bank of Vietnam (SBV) will be responsible for monitoring the raw material needs of the local gold industry. This will pave the way for these local SBV branches to grant import quotas to local businesses to import gold bullion. A small step, maybe, towards a more open gold market in Vietnam. 

Indian demand was up 26% y-o-y, reaching 40.7t. This is the third consecutive quarter of y-o-y growth, as India’s gold market continues to pick up from the low levels to which it fell at the start of 2016.³ Sales during Akshaya Tritiya were especially strong. As noted in the jewellery section, Akshaya Tritiya fortuitously fell on a weekend, and the extended sales period accounted for an estimated 15% of bar and coin demand for the quarter. 

Demand in Turkey was particularly buoyant. Having been in the doldrums for some time, retail investment demand has perked up, hitting its highest levels since 2013. A few factors have underpinned this. Turkey’s economy is recovering from the economic and political shocks it has suffered of late. In a recent paper, the Organisation for Economic Co-operation and Development  (OECD) noted that “economic growth is projected to edge up to around 3.5% in 2017 and 2018…[and].. consumer price inflation is back in double digits” Turkey’s leading stock index – the BIST 100 – has enjoyed a stellar 2017, reaching all-time highs. And, after falling precipitously last year, the Turkish lira has stabilised. The improving economy, inflation edging higher, and a strengthening local currency coincided with a near 9% drop in the local gold price between April and May. Investors took advantage of this to increase their gold holdings.

European investment demand was flat y-o-y: 40.3t compared to 40.9t a year ago. Like China, investment activity has eased compared to recent quarters. Demand was especially buoyant at the tail-end of last year and the start of 2017 as investors took advantage of price dips and looked to gain exposure to an asset that could provide some security in the run-up to a spate of national elections. Some of these worries spilled over into Q2 2017: in France, there was strong investor interest in the run-up to the election, with Napoleon premiums hitting a high of 5% at one point.⁴ But, in general, these worries have eased as the year has progressed. Rutte’s and Macron’s victories in the Netherlands and France respectively, and Angela Merkel’s Christian Democratic Union increasing its lead in the polls over the Social Democrats in Germany, have helped ease investor anxiety.

Tepid local price movement also contributed to a quiet quarter. There was some buying activity on the price dips, but not much. In contrast, equity markets performed relatively well, with the German and French bourses proving more enticing than gold for some investors.

The US market was weak. A range-bound gold price, coupled with the S&P 500’s steady march higher, resulted in Q2 bar and coin demand falling to 10.2t, its lowest level since Q3 2013. H1 2017 was 21.5t lower than H1 2016 - this was the biggest y-o-y fall in bar and coin tonnage globally.