The Real Reason Gold Is Working

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The Real Reason Gold Is Working

Hang around gold bug long enough and you learn they fall into 2 camps. The first only believes in holding physical gold. They want to see and feel it. When things go pear shaped, they reason, gold coins and bullion will be useful as a means of exchange and barter.

The second group is fine holding “paper” gold like exchange traded funds that hold physical good-delivery bars. Funds like GLD (SPDR Gold Shares) and IAU (iShares Gold Trust) give investors liquid and secure access to gold in the framework of a SIPC insured brokerage account.

In 2019, the physical gold crowd has gone quiet. The US Mint reports that 1 ounce gold Eagle coin sales are down 46% through October. This is their go-to product for buyers who want to “stack” – accumulate physical gold bullion coins for investment purposes.

Conversely, the World Gold Council reported just today that on a worldwide basis the aggregate holdings of physical gold ETFs/funds just reached an all-time high. A few data points here:

  • “In September, global gold-backed ETFs and similar products had US$3.9 billion of net inflows across all regions.”
  • These inflows increased “their collective gold holdings by 75.2t (troy tons) to 2,808t”.
  • The prior high was in late 2012, when gold was near $1,700.
  • The WGC notes that the current environment for gold-backed ETFs is very different now than in 2012. Back then, 66% of gold ETF/fund holdings were in North American based funds. Now, these funds hold 52% of the total. European funds own 44% and the balance sits in other regions.

Away from ETFs, the WGC also noted that:

  • COMEX (futures market) net gold longs reached all time highs last month with 1,134t of notional exposure.
  • Volatility skew in the options market was also at an all time high, a sign of bullish trader confidence in further upside.
  • While gold is not near its all time high (2012) in dollar terms, it is very close when denominated in other G10 currencies.
  • Worth a mention, but not in the WGC report: gold is actually at 30-year highs in Japanese yen terms and reached all-time highs in euro terms just last month.

Here are our thoughts on all this:

#1: The growth in gold fund assets outside the US shows that investors are using the yellow metal as a local currency hedge. Gold is priced in dollars globally, just like oil. And as long as US economic growth and Treasury yields remain better than most of the rest of the world, the dollar will continue to strengthen. Non-dollar investors see that, and they buy gold. And it doesn’t hurt that gold fund management fees are now well below the negative rates on offer in Europe and Japan…

#2: Non-US central banks clearly see the same phenomenon, and they have been buying gold aggressively in 2019 as well. First-half purchases totaled 374t, a record according to a WGC report published in July. Since central banks are bureaucratic institutions and therefore work to an annual budget, we would expect 2H 2019 to resemble those first half numbers.

#3: All this puts gold’s recent rally into a more productive investment framework than the typical narrative of “a non correlated hedge against financial asset risk/uncertainty”. Investment demand for gold is rising for a very specific reason: an ever-stronger dollar. Fund investors buy gold to hedge their personal/institutional exposure to weaker local currencies. Central banks buy gold to buttress their balance sheets without having to inadvertently fund the US budget deficit by purchasing Treasuries.

Final thoughts: First, gold should continue to work its way higher as long as the dollar remains strong.If your investment outlook assumes further dollar strength, gold is a reasonable place to park capital. Second, we sometimes get the question of whether we prefer physical or paper gold – the construct with which we started this section. Our answer is “both”. They serve different purposes and we see merits in an all-of-the-above approach.


World Gold Council report (free signup required to read):