Winter 2013

GOLD: All that glitters

Gold banglesThe gold price is expected to decline by 20% this year, likely to make the first annual loss in 13 years. Muriel Oatham finds that as American and European investors leave the market, the appetite for gold in Asia shows no signs of abating.

China is expected to overtake India as the biggest buyer of gold in the world by the end of 2013, but demand across a number of Asian countries generally remains high.

Albert Cheng, managing director, Asia Pacific, for the World Gold Council, says the Chinese market was transformed by deregulation in 2002.

Prior to this, gold was bought and allocated by the state. “Even jewellery manufacturers had to buy from the central bank. This regulated the price somewhat. But after 2002, producers and manufacturers could buy and sell gold at the market price.”

The global market for gold expanded significantly as a result of the participation of the West, following the financial crisis of 2008. Western investors rushed to buy gold both physically and via exchange-traded funds (ETFs), in order to preserve wealth and protect purchasing power in the face of falling markets and sovereign debt crises.

At the beginning of 2013, with European economies settling down and the American economy showing signs of recovery, investors began to withdraw from the asset class.

According to a Thomson Reuters gold survey, the first half of 2013 saw gold investment fall by 28% year-on-year to the lowest figure since 2009. Institutional divestments were the main drivers as investors sought to take profits from gold and move money elsewhere.

Gold purchases by central banks has slowed significantly, too. Research from investment bank UBS shows that central bank purchases between January and August 2013 were 40% lower than in the same period in 2012.

But global demand is being sustained by Asia, where investors have seen falling prices as an opportunity to enter or re-enter the market. “We have seen sustained demand from Asia for the last six to seven months, and there are no signs of this abating,” says Cheng.

So what is driving demand for an asset which is falling in value? Critics of gold investment point out it has few physical uses. And as an investment it depends on price rises to deliver value: it accrues no earnings and pays no dividends.

RECORD LEVELS
But the latest fall in value is not deterring investors in Asia, where individual buyers in particular continue to push gold purchases to record levels.

Gold boxDr. Peter Brooks, behavioural finance specialist at Barclays, says there are two strong drivers behind this sustained rush to purchase gold.

First, gold has strong religious and cultural significance in some Asian countries. This leads to a huge demand for gold jewellery, particularly during the wedding season between the months of November and December.

“The sheer size of the populations of India and Greater China, combined with their fast-growing middle class, means combined consumer demand for gold in jewellery is above (56%) of global demand,” says Brooks.

A secondary factor, he adds, is that Asian countries have suffered currency devaluations and deep falls in their financial markets in recent history.

“This may still be fresh in the memories of the generation with investible wealth and increases the safety factor of gold as a physical and transportable investment.” He says that the cultural familiarity with gold may also be transferred to people’s propensity towards it as an investment, in much the same way as many investors in other countries view real estate.

Cheng agrees that in Asia, gold is seen and used as a hedge against currency depreciation: as local currencies depreciate it is seen as a stronger investment.

Brooks says these differing motivations mean the type of gold demanded differs from country to country. India and Greater China dominate in jewellery demand, while Thailand and Vietnam almost exclusively demand gold in the form of bars or coins for investment.

“Both Thailand and Vietnam have gone through recent political and economic instability, so investors perceive gold as a safe investment and store of wealth in the face of such instability,” says Brooks.  

Frank Henze, managing director of SPDR ETFs, Asia Pacific, agrees that while India and China are seen as the most influential investors in the global gold market, other Asian countries are catching up.

He says the combined demand from Thailand, Vietnam and Indonesia has increased by 46% so far this year. And he expects this to continue.

“We see a further positive trend in other Southeast Asian countries, like the Philippines. And we could potentially see more gold demand from Japan due to a possible return of inflation.”

Henze, whose SPDR Gold Shares is the world’s largest gold ETF, says the market has split, with investment in physical gold outpacing synthetic investments.

The third quarter of 2013 saw a huge surge in demand for gold jewellery and record investment in gold bars and coins.
“But this was countered by sizeable outflows from ETFs, as Western investors reacted to a seemingly more positive outlook for the American economy,” he says.

Henze agrees that the cultural significance of gold means Asia differs from the rest of the world.

“Gold has a unique role traditionally in many Asian countries – it is widely used as a means to preserve and transfer wealth from one generation to the next.”

He adds that gold is still used in some parts of Asia as a medium of exchange or purchase of goods.

This differs hugely from other parts of the world, where gold is used as an investment product based on its qualities to preserve capital and to diversify portfolios. In this capacity, gold can therefore be replaced by another asset if that is deemed more suitable.

NEW ENTRANTS
While investment in gold ETFs has fallen globally; in Asia, the appetite for gold investment, combined with increasingly sophisticated investment infrastructure, has seen new entrants in the ETF market.

China has seen the listings of two new ETFs this year. The HuaAn Gold ETF and Guotai Gold ETF were launched on the Shanghai stock exchange in July.

The HuaAn Gold ETF overcame domestic restrictions preventing direct investment in physical commodities by tracking the performance of spot contracts on the gold bourse. Investors can then convert their contracts into bullion through the Shanghai gold exchange.

The two funds were reported to have reached 1.6 billion renminbi ($262.5 billion) in their initial funding, but Cheng predicts demand will be limited.

He says the advent of gold ETFs were very successful in opening up the market and increasing liquidity, particularly in America and Europe. But in Asia, where purchasing physical gold is far easier, via gold shops and banks, their adoption will be slower and take-up limited.

“China’s new gold ETFs will predominantly attract existing equity and ETF investors. The market will not grow that quickly.”

Conversely, in India, the government has attempted to place restrictions on the import and buying of gold in order to address its balance of payments problem.

Facing a record current account deficit, the Indian government attempts to persuade banks to stop promoting gold investment. The $300 million Reliance Gold Savings Trust reopened to new business in October, following a three-month suspension.

All imports of gold require a licence from the foreign trade office. The import of gold coins and medallions is currently prohibited. Bullion duty was raised to 10% in August, and buyers of gold have to pay in cash.

But as yet this does not appear to have dulled investors’ enthusiasm. “Even as import duty reached 10%, people are still buying gold, just less of it,” says Cheng.

Asia will continue to drive global gold demand. He expects Chinese consumption to exceed 1,000 tonnes by the end of the year, and India to near the 1,000 tonnes mark, which means the two countries will account for about 50% of the world’s gold demand.

Cheng says it is unlikely Chinese and Indians will stop buying gold. The sustained growth of the middle class across many Asian countries means more individuals are accumulating wealth and in turn using that to purchase gold.

“And as the Chinese government continues to promote the transition from an export-dominated economy to one driven by domestic consumption, gold jewellery sales will benefit.”

Brooks adds that cultural and seasonal factors, such as the Indian wedding season and the Chinese New Year celebrations, will sustain demand for gold jewellery.  

Faced with falling gold prices, families often buy more gold to fill their budget rather than spending less. And while investors continue to believe that gold will be a safe bet to increase in value,

Brooks says they see falling prices as an opportunity rather than an expression of risk.

“So you can perhaps claim some overconfidence on the part of consumers.”

But he says this overconfidence, combined with the familiarity of gold for cultural and religious reasons and its history as a good store of value, suggests that Asian gold investment will be sustained for some time to come.

©2013 funds global asia

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