In a single month this year 240 tonnes of gold were exported from London to Switzerland. That’s almost three times the amount that was exported in the whole of 2012. In total, 797 tonnes left UK vaults in the first half of this year - a massive amount. So what has caused the abrupt increase? And where is all the gold now?
Like most phenomena, it’s about supply and demand. One reason for the sudden outflow is a massive increase in the gold supplied for sale by Exchange Traded Funds (ETFs). These funds have been a major driver of the rapid rise in the gold price over the past 15 years, from US$200 per ounce in 2000 all the way up to around US$1900 in 2011.
The big sell off
ETFs allow investors to buy small amounts of gold, in the same way shares are bought and sold on a stock exchange. From their inception in 2004, gold-backed ETFs increased their holdings to approximately 85m ounces at the start of this year. But since then, the long-term trend of increasing their holdings has been reversed sharply and they have now sold more than 20m ounces, a 25% fall in their gold holdings for the year so far.
Why this sell off has happened is up for debate, but we do know that a lot of the gold these funds owned was held as large bars in London. These have been moved to Switzerland and that can mean one of two things. Investors may be moving their gold from paper-based funds, where you own a proportion of a fund’s gold, to allocated accounts in Switzerland where the investor owns specific bars. It’s also very likely that the bars previously owned by the funds are being melted down into smaller denominations for export to Asia.
The gold price is set globally by two main markets - London and New York. New York is the more visible market but the London Fixings, a twice daily auction, accounts for almost 90% of total gold traded.
The largest Asian Exchange, in Shanghai, represents just 1.5% of global demand. There is normally a small price difference, with Asian investors paying about 0.35% more on average than those based in London or New York, attributable to physical arbitrage issues. But in April this year the difference jumped to well over 3%, or $30 per ounce.
Snapping it up
This surge in demand for gold in Asia seems to have come about as a result of the large fall in price earlier this year. Demand has been difficult to meet due to Chinese import quotas and the Indian government’s efforts to reduce gold imports through additional taxes and even an outright ban on purchases. These factors have resulted in Asian investors paying a premium for gold above western prices.
A further issue revolves around speculation that the Chinese government is switching additional reserves from US treasuries to gold, reinforcing its role as a safe haven in the event of a catastrophic US debt default.
A story as old as the hills
This west to east flow of precious metals is far from new. The Silk Road between the Mediterranean and China brought rare silk to ancient Rome, paid for with a flow of western gold. Spices imported from India with European gold have resulted in hoards of Roman minted coins being found in India.
In the middle ages, this flow of gold to the east reduced Europe’s money supply, causing economic problems. Today, India is suffering a similar problem, but this time it is due to the flow of gold into the country. India now holds an estimated 20,000 tonnes of gold - most of it is held privately, though central bank holdings are significant too. Estimates of the volume of gold in Indian temples suggest that they alone could meet the demands of Indian investors for a decade or more.
A lot of the country’s savings are held in gold rather than rupees as a result. Rather than putting money in the bank, individuals buy small amounts of gold, reducing the amount of rupees available to invest in the productive side of the economy. Recent efforts to restrict flows into India seem to be working with a projected 5% fall in imports for the year. Others have suggested making it easier for gold owners to deposit gold in banks, allowing the gold to increase the amount of credit available and boosting the economy.
This is the only large scale case of a country where two currencies are in use concurrently. In crisis some countries have swapped their national currency for the dollar but have generally swapped back once the crisis has passed. But with the strong cultural affinity Asia has for gold, this flow from west to east is likely to continue regardless of any official efforts.