Are Gold Bugs Becoming More Interested in Physical Gold?

Wall St. Cheat Sheet

The price of gold has suffered an ugly correction since hitting all-time nominal highs above $1,900 per ounce more than two years ago. The precious metal recently posted its third consecutive quarterly loss, and hedge funds finally appear to be capitulating. However, physical gold demand is still strong as investors continue to question the health of the financial system.

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In the second quarter, total gold demand reached 856.3 tons, down 12 percent from a year earlier, according to the latest report from the World Gold Council. A heavy amount of outflows from exchange-traded funds was the primary cause of the decline. Demand for ETFs and similar products plunged 402.2 tons, compared to flat demand in the previous year.

Weakness in ETFs like the SPDR Gold Trust — the most popular exchange-traded gold product — caused total gold demand to drop by 23 percent in dollar terms to $39 billion, its lowest level in more than three years. A recent filing with the Securities and Exchange Commission shows that even billionaire fund manager John Paulson, one of the biggest gold advocates, slashed his stake in the SPDR Gold Trust by 53 percent in the second quarter.

While paper-related gold investments fell out of favor, physical gold was more popular than ever. In the second quarter, demand for gold bars and coins reached a record high of 507.6 tons, up from 285.9 tons a year earlier and well above the five-year average of almost 300 tons. During the same period, demand for gold jewelry rose 37 percent to 575.5 tons — new multi-year highs.

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Despite the decline in gold prices this year, demand for bar and coins surged 56 percent in dollar terms, while jewelry demand jumped 20 percent. Most regions experienced an uptick in demand, but China and India together accounted for almost 60 percent of the global jewelry sector and roughly half of total bar and coin demand. Europe was the only region not to see an increase in jewelry demand.

Amid falling gold prices, bargain hunters were largely responsible for physical demand. The World Gold Council explains: “Although jewelry demand is influenced by a wide set of factors, including economic growth, consumer sentiment and disposable income, to name a few, all were eclipsed by the effect of the drop in the gold price. The resultant buying frenzy caused a huge rise in regional premiums on gold, as supply chain bottlenecks caused delays in meeting demand.”

With the major central banks around the globe still practicing accommodating monetary policies, other central banks are loading up on assets that cannot be printed. In the second quarter, gold demand from central banks hit 71.1 tons, down from the previous year but above the five-year average of 50 tons.

The World Gold Council expects central banks to remain net buyers of gold for the rest of the year, but there may be a “slight drop-off in annual demand to between 300-350 tonnes.” However, that would still be roughly in line with the three-year average.

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During the second quarter, the price of gold plunged about 23 percent to reach its worst level since August 2010. In April, the precious metal fell $200 over the course of only two days. Since then, gold has managed to rally from about $1,180 per ounce to $1,365 per ounce, and recently posted its best week of the year.

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Disclosure: Long EXK, AG, HL, PHYS

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