Executive Summary
- With low-to-negative correlations with traditional asset classes as well as with major economic variables, gold is a proven asset diversifier.
- Ways to gain exposure with ETFs:
Physical Gold Bullion: GLD, IAU, SGOL
Gold futures: DGL
Gold miners: GDX, PSAU
Leveraged and Inverse: DGP, UGL, GLL
Investment case
A transcendent store value, gold is accepted the world over and may be an effective wealth preservation tool. Most importantly, due to its low-to-negative correlations with traditional asset classes as well as with major economic variables, gold is a proven asset diversifier. When used in the construction of diversified portfolios, gold potentially helps reduce overall risk and may ultimately help protect investor wealth.
Demand
Demand for gold is widely spread around the world. East Asia, the Indian sub-continent and the Middle East accounted for 72% of world demand in 2007. 55% of demand is attributable to just five countries – India, Italy, Turkey, USA and China, each market driven by a different set of socio-economic and cultural factors. Rapid demographic and other socio-economic changes in many of the key consuming nations are also likely to produce new patterns of demand.
Jewelry demand
Jewelery consistently accounts for around three-quarters of gold demand. In the 12 months to December 2007, this amounted to US$54 billion, making jewellery one of the world’s largest categories of consumer goods. In terms of retail value, the USA is the largest market for gold jewellery, whereas India is the largest consumer in volume terms, accounting for 25% of demand in 2007.
Indian gold demand is supported by cultural and religious traditions which are not directly linked to global economic trends.
Generally, jewellery demand is driven by a combination of affordability and desirability by consumers, and tends to rise during periods of price stability or gradually rising prices, and declines in periods of price volatility. A steadily rising price reinforces the inherent value of gold jewellery, which is an intrinsic part of its desirability. Jewellery consumption in the developing markets has been expanding rapidly in recent years following a period of sustained decline, but several countries, including China, still offer considerable potential for future growth in demand.
Investment demand
Because a significant portion of investment demand is transacted in the over-the-counter market, it is not easily measurable. However, there is no doubt that identifiable investment demand in gold has increased considerably in recent years. Since 2003 investment has representing the strongest source of growth in demand, with an increase in value terms to the end of 2007 of around 280%. Investment attracted net inflows of approximately $15bn in 2007.
There are a wide range of reasons and motivations for people and institutions seeking to invest in gold. And, clearly, a positive price outlook, underpinned by expectations that the growth in demand for the precious metal will continue to outstrip that of supply, provides a solid rationale for investment. Of the other key drivers of investment demand, one common thread can be identified: all are rooted in gold’s abilities to insure against uncertainty and instability and protect against risk.
Gold investment can take many forms, and some investors may choose to combine two or more of these for flexibility. The distinction between buying physical gold and gaining exposure to movements in the gold price is not always clear, especially since it has always been possible to invest in bullion without actually taking physical delivery.
The growth in investment demand has been mirrored by corresponding developments in ways to invest and there are now a wide variety of investment products to suit both the private and institutional investor.
Industrial demand
Industrial and dental uses account for around 13% of gold demand (an annual average of over 425 tonnes from 2003 to 2007 inclusive). Gold’s high thermal and electrical conductivity, and its outstanding resistance to corrosion, explain why over half of all industrial demand arises from its use in electrical components. Gold’s use in medical applications has a long history and today, various biomedical applications make use of its bio-compatibility, resistance to bacterial colonization and corrosion, and other attributes. Recent research has uncovered a number of new practical uses for gold, including its use as a catalyst in fuel cells, chemical processing and controlling pollution. The potential to use nanoparticles of gold in advanced electronics, glazing coatings, and cancer treatments are all exciting areas of scientific research.
Supply
Mine production
Gold is produced from mines on every continent except Antarctica, where mining is forbidden. Operations range from the tiny to the enormous. According to recent figures, there are around 400 operating gold mines worldwide. Today, the overall level of global mine production is relatively stable, averaging approximately 2,525 tonnes per year over the last five years. New mines that are being developed are serving to replace current production, rather than to cause any significant expansion in the global total.
The comparatively long lead times in gold production, with new mines often taking up to 10 years to come on stream, mean mining output is relatively inelastic and unable to react quickly to a change in price outlook. The incentives promised by a sustained price rally, as experienced by gold over the last half decade, are not therefore easily or rapidly translated into increased production.
Scrap
However, although gold mine production is relatively inelastic, recycled gold (or scrap) ensures there is easily traded supply when needed, and this helps to stabilise the gold price. The value of gold means that it is economically viable to recover it from most of its uses, where it is capable of being melted down, re-refined and reused. Between 2003 and 2007, recycled gold contributed an average 26% to annual supply flows.
Central banks
Central banks and supranational organisations (such as the International Monetary Fund) currently hold just over one-fifth of global above-ground stocks of gold as reserve assets (amounting to around 29,000 tonnes, dispersed across 110 organisations). On average, governments hold around 10% of their official reserves as gold, although the proportion varies country-by-country.
Although a number of central banks have increased their gold reserves in the past decade, the sector as a whole has been a net seller since 1989, contributing an average of 520 tonnes to annual supply flows in 2003-2007. Since 1999, the bulk of these sales have been regulated by the Central Bank Gold Agreement/CBGA (which stabilises sales from 15 of the world’s biggest holders of gold). Net central bank sales amounted to just 500 tonnes in 2007.
Gold production
The process of producing gold can be divided into six main phases: finding the ore body; creating access to the ore body; removing the ore by mining or breaking the ore body; transporting the broken material from the mining face to the plants for treatment; processing; and refining. This basic process applies to both underground and surface operations.
The world’s principal gold refineries are based near major mining centres, or at major precious metals processing centres worldwide. In terms of capacity, the largest is the Rand Refinery in Germiston, South Africa. In terms of output, the largest is the Johnson Matthey refinery in Salt Lake City, US.
Rather than buying the gold and then selling it onto the market later, the refiner typically takes a fee from the miner.
Once refined, the bullion bars (with a purity of 99.5% or higher) are sold to bullion dealers who, in turn, trade with jewellery or electronics manufacturers or investors. The role of the bullion market at the heart of the supply-demand cycle – instead of large bilateral contracts between miner and fabricator – facilitates the free flow of metal and underpins the free market mechanism.
Source: The World Gold Council
Overview
ETF investors have several choices for gaining exposure to gold including funds that hold physical gold, invest in futures contracts or own gold mining stocks. Leveraged and inverse funds are also available.
Physical Gold
With over $35 billion of assets, theSPDR Gold Shares (GLD) is the largest gold ETF. The Gold Shares represent fractional, undivided interests in a Trust that holds physical gold bullion.
The iShares Comex Gold Trust (IAU) and ETFS Physical Swiss Gold Shares (SGOL) also track the price of gold by holding bullion.
Gold Futures
The PowerShares DB Gold Fund (DGL) tracks a rules-based index composed of futures contracts on gold and carries an expense ratio of 0.50%.
Gold Miners
The Market Vectors Gold Miners ETF (GDX) invests in a diversified group of companies involved primarily in the mining of gold. Top holdings include Barrick Gold Corp,Goldcorp and Newmont Mining.
The PowerShares Global Gold and Precious Metals Portfolio (PSAU)invests in the largest and most liquid companies involved in gold and other precious metals mining-related activities. Top holdings includePlatinum Holdings, Goldcorp andBarrick Gold.
Leveraged and Inverse
The PowerShares DB Gold Double Long ETN (DGP) shares are two times leveraged with respect to the gold index and are senior unsecured obligations of Deutsche Bank AG, London Branch.
The ProShares Ultra Gold (UGL)fund seeks daily investment results, before fees and expenses, that correspond to twice (200%) the daily performance of gold bullion. TheProShares UltraShort Gold (GLL) fund seeks daily investment results, before fees and expenses, that correspond to twice (200%) the inverse (opposite) of the daily performance of gold bullion.
Top Performers
Largest
SPDR Gold Shares (GLD)
Lowest Cost
ETFS Physical Swiss Gold Shares(SGOL) – 0.39%
See the directory.