Gold ETP redemptions will continue

In 2013, gold prices fell 28 per cent in dollar terms. The collapse started mid-April from $1,660/oz and by June prices fell to $1,181/oz, the lowest since mid-2010. After some recovery, rates declined to $1,182/oz again in December.

After the bloodbath in the second half of 2013, the beginning of 2014 has been more positive for the yellow metal which now trades at around $1250/oz. The world gold market has been hobbled by many negative shocks; the main shock being the large-scale redemption from physically-backed exchange traded products (ETPs). From the peak accumulation of over 2,600 tonnes, the outflow last year was a staggering 900 tonnes.

The massive outflow prompted questions as to where has the metal gone. Based on trade data, it is clear there were large exports to Switzerland — home to large refineries. From there, the metal travelled to traditional consuming markets such as China, India and Turkey, experts assert. In other words, physical gold travelled on a large scale from the West to the East.

Tapering A significant reason for the gold price collapse was the US Federal Reserve’s repeated assertion that ‘tapering’ of asset purchase was inevitable. Such tapering obviously reduces the liquidity in the market. Another factor that contributed to the negative shock is the lower demand from central banks around the world. Given that India has been the world’s largest importer, the Indian Government’s stringent restrictions on gold imports worsened the price situation.

If 2013 saw outflow of 900 tonnes, how would 2014 fare? There is a distinct slowdown in outflows. In January, the outflow amounted to 24 tonnes only. As said earlier, the sentiment towards gold that had worsened late last year has improved somewhat now. The reasons for the slowing ETP redemption include: index fund rebalancing for the new year, poor US economic data and weaker equity markets. However, these factors are likely to bring only a temporary relief.

There is widespread belief that in 2014, recovery in institutional investment appears unlikely as the world economy continues to show signs of growth under the lead of the US. This is likely to lead to a firmer dollar. Also, inflation expectations are well anchored. Although there are undercurrents of tension, the geopolitical situation too is not turbulent.

Demand Demand will drive gold prices in 2014. Chinese demand has been strong so far, but will it continue? The Chinese Lunar New Year demand surge felt in the last two months is weakening. So, the downside support is already being tested. On the other hand, physical demand in India is constrained by policy restrictions. Although some benign noises are made from time to time about easing the controls, no major decision is likely anytime soon with general elections looming.

A firming dollar and improving equity markets can potentially create downside risks for the yellow metal. ETP redemptions this year are forecast at about 500 tonnes. With every fall in market price, gold in ETPs becomes less-profitable. The non-farm payrolls data this week is a factor to watch out for. Overall, gold faces downside risk and will struggle to hold on to its $1,200 levels.

COMMENT NOW