Gold in hands

So far during 2014 the price of gold is up 9%, measured in US dollars. But between September 2011 and December 2013 the price fell 37%. Evidence suggests this was driven by large scale selling of gold-backed ETF shares, causing them to dump bullion onto the markets. But there is good evidence this selling stopped earlier this year. So is the gold bull market back on?

Gold started out this year priced at $1,207 per troy ounce. By 17th March, less than three months later, it had risen 14% to $1,382 per troy ounce. I wrote around that time that I thought it had probably gone up too fast there was a good chance of a pull back.

This is exactly what happened shortly afterwards: the price fell to $1,245 per troy ounce on 3rd June, down 10% from the March high but still up 3% since the beginning of the year.

At the time of writing the price is back up to $1,316 per troy ounce, which is a 9% gain year-to-date in 2014. This feels like a more sustainable level, after a nearly six month period has passed for that dollar price rise to happen.

But as with all liquid, traded assets – especially those with derivatives markets linked to them (which is to say most of them) – it’s impossible to know what will happen in the short term. Prices could rise, or fall, or do very little.

 …physical gold is likely to remain in high demand in the future in large emerging markets such as China and India.

However, as I’ve explained before, I believe that physical gold is likely to remain in high demand in the future in large emerging markets such as China and India (not to mention the Middle East).

Most of the vast numbers of people in those countries remain poor by global standards. But they have deeply ingrained traditions of owning and giving gold. As they become progressively, but not necessarily steadily, wealthier they are likely to buy even more of it. (If you want a further understanding on the growing population around the world, and the demand fro precious metals. Read chapter 1 of our Report Wealth Workout, you can download for free here )

So has the bottom of the gold bear market already passed? After all, gold fell from an all time high of $1,894 per troy ounce in September 2011 to a low of $1,196 per troy ounce in December 2013. That’s down 37% – a bear market by anyone’s standards.

The truth is it’s impossible to know. I believe the fall was mainly driven by large scale selling by investors in gold backed ETFs (exchange traded funds), who are mainly based in the US and other developed countries. For gold to rise we need that selling to stop or reverse, and for physical buying of jewellery, coins and bars to continue in China and India.

There is good evidence that the ETF selling has come to an end. The SPDR Gold Shares ETF (NYSE:GLD) dominates the world of gold-backed ETFs. It’s been running since November 2004, which makes it positively ancient in ETF terms.

These things only really took off in the early 2000s, offering a lower cost and more liquid way to invest than traditional investment funds. GLD was the first of the gold-backed ETFs and continues to command roughly half of the gold ETF market.

GLD’s current market capitalisation (total value at current market prices) is $33.3 billion, which is over 4.8 times as large as next biggest iShares Gold Trust (NYSE:IAU), with a market cap of $6.9 billion.

…sell off of 16.9 million troy ounces over just over two years is equivalent to 525 metric tonnes, which in turn is 18% of annual mined gold supply (just from one ETF).

GLD has had a stable amount of gold backing since January this year. Currently it has 25.2 million troy ounces of gold. That’s down a massive 40% since the most recent peak of 42.1 million ounces on 8th August 2011. To put that into perspective, that sell off of 16.9 million troy ounces over just over two years is equivalent to 525 metric tonnes, which in turn is 18% of annual mined gold supply (just from one ETF).

But the amount of gold held by GLD has been stable since January, give or take a few hundred thousand ounces. And it’s even up 0.6% since 12th May, when it bottomed out at 25.1 million ounces.

Of course there’s no guarantee that the gold ETF sell off can’t resume. But after five months of stable holdings in the dominant GLD ETF, and a 40% drop in ounces since late 2011, it’s highly likely that we’ve seen the end of the main wave of selling.

We also don’t know what’s been driving the price up recently. It could be concerns over the situation in Iraq (now that the Ukraine crisis is slowly moving out of the media’s sights). Or it could be renewed concern about inflation. Or it could simply be continued buying in China and India (I’m looking forward to seeing second quarter supply and demand data when it becomes available).

But one thing is for certain. If the wave of selling by ETF investors is over then it significantly improves the chances that the longer term, secular bull market that started in 1999, at $256 per troy ounce, is back on.

Stay tuned OfWealthers,

Marco Polo

marcopolo@ofwealth.com