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The demand for gold investments reached a record 1,064 tonnes in 1H. This is the highest 1H demand since 2009, when the financial market was reeling from the global financial crisis. Are gold investors preparing for the next crisis?
The demand from gold comes from four main sources: jewellery, technology, investment, and reserve asset management. Of the four, jewellery demand accounted over half of total gold demand. But anaemic jewellery demand amid high prices has eroded the demand share since 2006. The ratio of jewellery demand to total gold demand fell from 74% in 2006 to 57% in 2015, while total gold demand grew 36% in the ten-year period.
On the other hand, investment demand almost doubled its share from 14% in 2006 to 25% in 2015. The reason for the recent surge, however, was not so much from physical gold investment demand, than from the rise of gold-backed ETFs. In 1H 2016, gold-backed ETFs were the major driver for investment demand, accounting for 54%. In contrast, they were a drag on investment demand in the previous three years.
What drove the demand in gold-backed ETFs? One explanation was investors looking for opportunities to re-enter the market after being washed out in early 2013 found they had sufficient reasons to do so this year. These are investors who seek to rebuild strategic long-term positions.
While the fact that demand for gold investments hit the highest since 2009 may raise fears of another global crisis, there are strong reasons for the higher demand. A number of factors have attracted gold bulls in the first semester of this year.
Global monetary policy remains at the forefront of global financial markets. The negative interest rate policies (NIRP) of Europe and Japan, alongside prospects of very gradual rise in US rates, fuelled investors’ optimism on gold. Second, a variety of events this year also raised market uncertainty, including China’s stock market turmoil, UK referendum on EU membership, US election, Italy’s fragile banking sector, geopolitical unrest in the Middle East, among others. Third, the dearth of suitable investment opportunities with decent returns led investors to consider gold.
Gold-backed ETFs to go on?
Before you rush to buy into gold-backed ETFs, it’s wise to note that there are signs of profit-taking in gold. Gold demand from ETFs slowed from 343 tonnes in Q1 2016 to 237 tonnes in Q2 2016. Gold prices have traded mostly sideways between $1310 and $1360 since the Brexit vote. It may be reasonable to assume that the recent momentum may be hard to sustain, at least for the time being. Added to that is the lacklustre demand for gold jewellery as the higher price level takes its toll in the more price-sensitive jewellery sector.
But the current environment outlined earlier remains favourable to the precious metal. In particular, if we continue to see latent demand from investors looking to re-enter the gold market, there would be more room for gold prices to run higher.
One last thing, Gold and Silver
Gold and silver tend to move together. The only difference is the magnitude of the price movement. Silver is typically more volatile than gold because the liquidity for silver is not as deep as for gold. Therefore, it does not take as much transactions to move the price of silver.
Because of the strong correlation between the two precious metals, investors monitor the gold-to-silver ratio to assess how expensive or cheap silver is, relative to gold. In the last 30 years, the ratio has fluctuated between 45 and 80. In 1H, the ratio is close to the upper end of the range, and currently seen at around 70. This tells us that silver is still cheap compared to gold.