Gold may suffer short term damage on ETF outflows

Ajeet Kumar The rally which had been seen in gold prices in last 2-3 years was mostly the fruitful outcome of robust investment demand coming from exchange traded fund (ETF). Also, this new avatar of investment has recently been a major source of gold demand, with the three largest fund operators SPDR, ETF Securities and Zurich Cantonal Bank adding 18.216 million ounces of gold to their holdings in the two years to January 2011. This is just equal to a year`s gold output from top producers China and Australia. But current outflows from physically backed exchange traded funds has not only hampered the momentum of the price-rally, but also detracted the jubilancy of its value as most productive and safe asset. Most of the ETFs are now reeling under a phase of constant selling. For example, the largest gold ETF -- the SPDR Gold Trust -- recorded its second-biggest monthly outflow in January this year while gold prices posted their worst monthly decline since December 2009. Net inflows into gold via exchange traded funds and similar investment options however remained robust during 2010, as gold-backed ETFs that the World Gold Council monitor had attracted net inflows of 361 tonnes. This pushed total holdings to a new high of 2,167.4 tonnes by 31 December 2010, worth USD 98 billion as investors saw in gold an invaluable asset for risk management and hedging purposes. SPDR Gold Shares (GLD) listed on the NYSE and cross-listed in Mexico, Singapore, Tokyo and Hong Kong attracted net inflows of 147.1 tonnes in 2010, mostly driven by hectic buying during second quarter. As per analyst, positive US economic data had increased interest in cyclical assets like stocks last month at the cost of safe havens such as gold. January was the first time that falling prices accompanied heavy selling from the fund. In January SPDR ETF holdings saw a decline of 53.6 tonnes, while in December 2009 its holdings had actually increased by more than 3 tonnes as prices fell. Rapid recovery in US economy led to the belief that fixed income securities are more attractive than gold, as interest rates were expected to go up. The signs coming from the US central bank also endorsed this expectation. Continuous warnings of different rating agencies and the International Monetary Fund to the US and many other heavily-indebted rich nations also slashed the brightness of gold by strengthening the belief that higher interest rates phase may glitter the value of dollar as compared to gold. Standard & Poor`s had already downgraded Japan last month and raised questions about which country would be downgraded next? Japan, the United States, Britain and peripheral Europe still harbour economic problems that make drastic spending cuts difficult to stomach. Meanwhile, IMF has again reasserted that a possible global economic slowdown stemming from Europe`s sovereign debt problems could affect currency and stock markets and weigh heavily on Japan`s growth prospects. Euro zone countries are now working on a "comprehensive" package of measures to try to resolve their year-long debt crisis, with the aim of completing a deal by the end of March. But a lack of consensus over details of the package means negotiations are progressing slowly. Increased sign of disagreement in Europe could damage confidence in Europe`s ability to prevent sovereign debt woes from spreading to other countries, potentially pushing up yields on government debt. Technical analysts have also been in favour of bears. They say gold prices had already reached the peak and now there is a maximum possibility of correction. But some other analysts contend this is just a temporary correction and that medium to long term prospects still remain bullish. Shitij Gandhi of SMC Global Securities opined that the fall in SPDR Gold Shares holdings in January 2011 is the second-largest monthly outflow since April 2008 as investors favoured equities and industrial commodities over perceived safe havens. Despite the fall in January, he believes that investment in Gold ETFs in emerging countries led by China and India will leap by at least 25-30% in 2011 as a clutch of mutual funds, banks and private sector companies are getting ready to tap the ETF sector in these markets. Other senior analysts maintain that the sentiments are looking bearish as per view of US investors. But Asian and European sentiments’ are still goes along with bright prospect. In US bargain hunters and speculators are now selling shares (whose gold are in the hands of a bank) to buy physical gold in overseas for safer keeping. However, recent decline in prices will probably close out rest of the positions in near term. But on the other side in emerging economies like India and China, investors are showing more confidence in gold and silver by preferring it as real money and best assets for financial security. Their rising buying strength shows that they may well prove to be the dominant force in the gold market from now on. There is more or less unanimity over the issue that central banks of these countries will continue to buy for their reserves. Last month Russia announced that it will be buying 100 tonnes of gold per annum henceforth. Reserve Bank of India & People’s Bank of China are following the same course. More hikes in Chinese benchmark interest rates may also give benefit to gold`s status as an inflation hedge. The Chinese Central bank raised interest rates by a quarter points to 6.06 percent in earlier February, it is the second increase in just over a month as it stepped up its fight against stubbornly high inflation. Gold’s most glittering version in form of demand for jewellery is also rising back to the levels seen in the past, making it the single largest element of demand in the gold market. As far as Europe is concerned, gold may remain a better choice for buyers as the prospect of a Euro zone default could have endangered the Euro itself. Analyst do not believe that the danger has passed, but some European institutions may well feel that. They may have had holdings in the US SPDR gold ETF, believing liquidity is better there. Industrial and Technological demand is also growing steadily and will continue to do so for gold. Overall the fundamentals of gold remain positive for the long term, but in the short to medium term pull back can extend.