Gold Demand Trends Update: Paper Gold Sell-Off Despite Insatiable Hunger for Physical Gold

Gold Demand Trends Update: Q1 2021

On April 29, the World Gold Council released a comprehensive overview of the various drivers behind gold demand in the first quarter of the year, as well as covering some supply insights. Here are the most interesting parts…

Gold demand falling?

The 23% year-on-year decline in demand would, at first glance, have one believe that gold is falling out of favor. Yet, as the report notes, the percentage is almost exclusively attributed to a combination of paper gold fund outflows and central banks temporarily becoming net sellers.

Paper gold dumped (especially in the U.S.)

Publicly-traded gold ETFs (including but not limited to SPDR Gold Shares: GLD, iShares Gold Trust:IAU, Goldman Sachs Physical Gold ETF:AAAU, Invesco Physical Gold: SGLD) have been net sellers of gold for five of the last six months. January was the sole outlier with a net gain of a mere 14.3 tons globally.

What’s going on?

There are a variety of explanations: investors are pivoting into the stock market, in the hopes the stimulus-fueled boom in markets will somehow become sustainable. Investors saw the massive inflation in basic materials reported in March and moved their commodity bets away from gold, into base metals, lumber and other industrial raw materials. Or perhaps Americans learned to prefer gold they can hold in their hands to a line item on their brokerage statements, and sold paper to buy physical gold?

That would explain the extreme supply shortages gold dealers have experienced all-too regularly since early 2020. And also the reason the U.S. Mint rationed precious metals coin sales…

Interestingly, while Western funds sold off their gold, Asian funds were eager to load up on them. Chinese funds bought 11.5 tons of gold in Q1 to boost their holdings to a record 72.4 tons, with the rest of Asia reinforcing the trend of the flow of institutional gold from West to East.

The rest of the gold demand story is, well, pretty simple. Everybody wants gold.

Gold jewelry boom

From a broader perspective, it looks like gold demand is ramping up on all sides. The report points to a 52% year-on-year increase in jewelry demand, showing a massive recovery in consumer purchases in this quarter compared to the previous year. While gold demand still has room to recover in this sector, there are already numerous promising figures. The $27.5 billion spent on the 477.4 tons of gold jewelry is the highest first-quarter amount since 2013, and also 25% above the five-year quarterly average.

Although China spearheaded jewelry demand with 191.1 tons in Q1, the highest quarterly figure since 2015, and India trailed with 102.5 tons, other parts of the world showed strong jewelry purchases as well. Despite a lot of tumult in the country over the quarter, Turkey still posted a 5% year-on-year increase in jewelry purchases over the period.

In addition to a number of smaller Asian nations, the U.S. consumer base looks to have strengthened, with domestic jewelry demand growing 6% year-on-year to 24.3 tons, the highest Q1 figure since 2009.

Consumer demand for physical gold highest ever

The flow of gold from Western funds we discussed above stood in stark contrast to investment demand on the consumer side.

Q1 was the third consecutive quarter of growth in gold coin and bar demand, climbing to 339.5 tons, the highest quarterly figure since 2016. Investment demand was strong across all regions, with the U.S. posting a 77% year-on-year increase of 26.3 tons, double the five-year quarterly average.

China’s 86 tons of investment gold bought in Q1 were a massive 133% year-on-year increase and a 21% increase compared to Q1 2019. Indian retail investment grew for the third quarter in a row to reach 37.5 tons, a 34% year-on-year increase, while Turkey’s 44.3 tons were an almost double year-on-year increase.

Manufacturers bought almost as much gold as central banks

After last year’s back-and-forth, central banks returned to net purchasing with 95 tons of gold bought in Q1, and the report expects the official sector to continue with strong purchases throughout the year. The often-overlooked technology sector saw an 11% year-on-year increase in gold purchases, amounting to a total of 81.2 tons, with 66.4 tons coming from electronics manufacturers.

Gold production snapshot

Despite a recovery in mine production, overall gold supply in the first quarter fell by 4% year-on-year, amounting to 1,146 tons compared to the 1,096 tons supplied over the same period last year.

In short, it looks like the shortage we’ve seen in physical gold coins and bullion since 2020 won’t get better anytime soon. It might get worse first, between China’s big imports for consumers and citizens of crisis-stricken nations desperate for gold as a safe store of value (Turkey’s lira crisis and India’s COVID emergency).

Big Gold Purchases By Central Banks: Bad News for U.S. Dollar?

Central Banks Buying Gold - Bad News for U.S. Dollar?

According to data published by the World Gold Council, global central banks haven begun adding to their gold stockpiles. In February, the following nations added to their reserves:

  • India (11.2 tons)
  • Uzbekistan (7.2t)
  • Kazakhstan (1.6t)
  • Colombia (0.5t) 

The only notable sale of central bank gold reserves was from Turkey at 11.7 tons.

Why did Turkey’s central bank sell gold?

Nations hold gold reserves as a sort of collateral against their sovereign currency. Turkey’s currency, the lira, had a horrible day on March 22 and lost 20% of its value. In response, Turkish President Recep Tayyip Erdogan made an appeal:

I ask my citizens to invest their foreign currencies and gold in various financial institutions and bring [those assets] into the economy and production.

via BalkanInsight

Put simply: if his people listened to Erdogan’s plea and swapped all their U.S. dollars and euros and precious metals for lira, demand for lira would increase. And therefore prices would increase. It’s reasonable to assume the Turkish central bank sold gold in order to buy lira in an effort to prop up the beleaguered currency.

Note that even after this sale, Turkey has a respectable 716 tons of gold reserves.

What other central banks are buying gold?

More recently, central bank gold purchases have been in the news.

This month, Hungary announced its intention to triple its gold reserves “to help stabilise the economy amid the COVID-19 pandemic, inflation risks and rising debt.”

Back in March, Poland decided to buy 100 tons of gold.

The Reuters article even hints at a possible explanation…

Over the last decade central banks, particularly in Eastern Europe, the Middle East and Asia, have stepped up purchases of gold, often seeing it as a way to reduce reliance on assets such as the U.S. dollar.

Reuters

Is central bank gold buying a bad sign for the dollar?

Not necessarily. Most central banks around the world hold a combination of foreign exchange reserves (a collection of the world’s most-used and/or most-stable currencies) in bonds as well as gold or other precious metals.

So, in a sense, any government that issues bonds is competing for central bank customers. For the most part, only the most common currencies are considered useful as foreign exchange reserves. According to the IMF, the top five are:

  • U.S. dollar
  • euro
  • China’s renminbi
  • Japan’s yen
  • U.K.’s pounds sterling

So anytime the U.S. Federal Reserve, the Bundesbank or the Bank of England issues a bond (a promise to pay later for cash now, or an IOU), there are other global central banks who are potential customers. Along with them, what you might think of as the “traditional” customers for bonds like pension funds, insurance companies, individual savers, etc. also want bonds. More customers means more demand, and more demand means higher prices.

But what if some of that central bank demand is diverted out of bonds, into gold?

That means a diminished demand for bonds. That means a slight upward pressure on the interest rate issuing banks must offer to attract buyers. Which makes deficit spending more expensive. Sovereign bonds can also lose value to inflation.

Further, as mentioned in the Reuters article, gold isn’t subject to counterparty risk. There’s always the chance, however small, that a nation might choose to stop paying its bond-holders. (This is called a default, or a sovereign debt crisis, and they happen fairly regularly.)

There’s zero chance of physical gold defaulting. Once those gold bars are locked up in a nation’s central bank vaults, it serves as a permanent store of value.

In an important sense, when a central bank chooses to add to their gold reserves, the decision says, “We’re diversifying our country’s savings out of currencies we don’t control, into an asset class that we can trust.”

2021: Deficits, Inflation, Overvalued Stocks Drive Gold Higher

In 2021 Deficits, Inflation, Overvalued Stocks Drive Gold Higher

The factors that drove gold to a new all-time high of $2,067 last year are well-known. The unprecedented amount of global panic caused a flock towards precious metals, one that had just as much to do with reactionary government policies as the crisis itself. Over the span of 12 months, gold gained around 25% while silver topped a seven-year high and became the main item on many a watchlist. In their Gold Outlook report for 2021, the World Gold Council (WGC) stated that it expects gold to post an almost as strong of a performance this year due to a combination of new and existing tailwinds.

Inflated stock valuations are a boon for gold

According to the report, the stock market is again shaping up to be a massive red flag. Long before the crisis hit, many experts were warning that equities’ valuations are overblown and that the longest bull run in the market’s history is slated for a correction, if not an altogether crash. The WGC points out that the S&P 500 price-to-sales ratio is at historic highs, yet also likely to expand further.

Near-zero bond yields send investors to gold as a safe haven

With the effective elimination of most sovereign bonds from portfolios, investors will now look to take on a more risk-on approach in search of gains, said the WGC. The renewed appetite for risk will also be powered by optimism in regards to a rapid global economic recovery after one of the worst slowdowns over the past century. The increased reliance on dubiously-valued stocks is likely to bring on strong pullbacks and market swings. While this turbulence alone is beneficial to gold, the metal is likely to receive even more support as higher risk will place more emphasis on hedging, especially in the absence of bonds that formerly fulfilled this role.

Inflation fears and inflation-resistant assets

Though not yet materialized in substantial form, inflation has been on the mind of every market participant ever since the government decided to expand the money supply with an unseen multi-trillion dollar stimulus. With the Federal Reserve and the European Central bank both stating their willingness to allow inflation to run past the targeted rate of 2%, the WGC’s report notes that gold prices increased by 15% on average during years where the inflation rate exceeded 3%. Of course, inflationary policies are just one of gold’s government-backed tailwinds, with ballooning budget deficits and the aforementioned normative of low to negative-yielding debt acting as pillars of support on their own.

Overseas gold demand increases

While last year’s demand for physical gold reached sky-high levels on one side, it was subdued from another as economic activity from the world’s top gold consumers slowed. The WGC expects this to change in 2021, projecting that consumer demand for gold from both China and India will return to form. The report cites data from the Indian Dhanteras festival in November as evidence that jewelry demand is already well on the track to recovery, having bounced back from the Q2 lows.

Central banks influence gold’s price

In contrast to 2018 and 2019, two record years in terms of central bank purchases, the WGC’s report forecasts a change in dynamic. With gold prices being near all-time highs, central banks could alternate between buying and selling, along with purchases no longer being widely spearheaded by Russia. Nonetheless, the WGC says that the official sector will continue to offer strong support for gold in the ever-growing bid to diversify foreign reserves, especially during a time of questionable fiat.