Get physical with gold

At the end of August 2020, gold stocks held by Exchange Traded Funds (ETFs) and Exchange Traded Commodities (ETCs) reached an all-time high of 3.844 tonnes. Since the beginning of this year, inflows amounted to 622.1 tonnes in North America, 278.6 tonnes in Europe, 36 tonnes in Asia and 20.7 tonnes in other regions. The largest holdings are in the US (1,984.7 tonnes), the UK (756.6), Germany (392.9) and Switzerland (363.5 tonnes). However, in August total inflows slowed to the lowest month-on-month increase in the last nine months of 38.8 tonnes (North America: +38.9 tonnes, Europe: minus 10.9 tonnes, Asia: +8.9 tonnes, other regions: +1.9 tonnes). This might be a reflection of financial markets calming down, and investors becoming less risk-averse. 

It seems that seeking exposure to the gold market via ETFs and ETCs has become increasingly attractive from the viewpoint of many investors. This is true in particular for institutional investors, as they quite often have, due to regulations, no other option to enter the gold market than via purchasing gold ETFs or ETCs. But also private investors seem to find gold ETFs and ETCs attractive, as they offer a rather convenient and low-cost strategy to participate in the market for gold. 

It is interesting to see that there has been a rather positive and close relation been the gold stocks held by ETFs/ETCs and the price of the yellow metal (see figure 1). This clearly begs the question of causality: Do price changes in gold induce changes in the demand for ETFs/ETCs? Or is the reverse true: Do changes in the demand for ETFs and ETCs induce changes in the price of gold?

There is probably no easy answer to this question. But given the latest inflows into gold ETCs and ETCs, it should be clear that these financial vehicles have become increasingly important players in the gold market. They have not only simplified and broadened access to the gold market; they also have lowered the costs of trading gold.

However, investors should be aware that the risk profile of holding physical gold (in the form of bars and coins) is rather different from investing in gold ETFs/ETCs. If you hold physical gold (in, say, a safe deposit box outside the banking system), you are not exposed to the risks that typically come with ETFs and ETCs – such as, for instance, counterparty risk, the risk of discrepancies between the physical gold price and an ETF/ETC share, risk that losses may occur from actively managed ETFs/ETCs, the risk that redemptions may be subject to postponements, etc.

If the investor is interested in benefitting from gold price changes, and if they are not concerned by other risk factors, purchasing ETFs and ETCs are certainly a proper way to put this strategy into practice. If, however, the investor wishes to hedge against the conspicuous risks that come with today’s world-wide paper money system, holding physical gold should be given priority. 

As a final note, gold has been an effective hedge against monetary inflation (see figure 2). From the beginning of 2000 until the middle of September 2020, the US “total monetary liquidity” has increased by around 350 per cent, and the price of gold has gained 570 per cent. While it may still be open for debate, we believe that the price of gold does not only compensate against inflation but also tends to reward the investor for credit risk, at least over the medium- to long-term. Against this backdrop, holding gold is effectively risk-reducing and return-enhancing for the long-term oriented investor.  

Thorsten Polleit. Chief Economist of Degussa