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Is physical gold demand negatively related to price?

by on July 7, 2016

A few years ago the discussion was all about the flow of gold east, as India and China bought in increasing quantities. As the below chart from Bullionstar shows, that’s reversing with net inflows to the UK gold market for the year so far. This coincides with rising prices and falling demand from gold buyers whose motives for buying are more cultural than profit maximising – such as India (jewellery demand volume down 41% q on q) and China (jewellery demand down 17% q on q). Stats here from the WGC.

The question is then – does who buys the gold matter for its price? Do physical buyers and investor purchases have different effects on the gold price?

It is possible that the traditional  buyers of gold, who kept buying through the period of falling prices, provided little or no support for gold prices. Their purchases are normally physical which implies that they are not planning to sell in the short term as there is a big transaction cost to trading in your jewellery or coins. Their purchases then seem to be a medium to long term withdrawal of liquidity from the gold market. A fall in liquidity should, all being equal, lead to an increase in the risk of holding gold. This would drive the price down to increase the returns from holding gold for prospective buyers.

The recently rising gold price has been associated with increases in ETF holdings. After 3 years of large outflows q1 2016 had a 363 tonne inflow, data from the WGC again. The largest annual inflows were in 2009 and 10 at 644 and 420 tones, so 2016 could be the biggest year for  ETFs to date if that then holds. These purchasers are buying gold in a way that increases it’s liquidity and it’s possible that this is part of the reason for the price rise. Their reasons for buying are assumed to be related to golds safe have status. A summary of the research on gold ETFs is available here.

The effect of changes in physical demand on gold is under researched by academics. 3 of the authors of this blog are currently working on a paper and when we have something I will post it here. But it’s possible based on the above ideas that physical demand is not a price support in the same way as paper demand.

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