With the GFMS figures out now, it has been confirmed what we suspected since October – global investment demand for gold outstripped jewelry demand for the first time in three decades. The traditional relationship between the price driver – the Comex trading, and price floor (determined by the physical demand) has been transformed by the success of the ETFs and increased interest in other gold investment products. In the first quarter of 2009, gold price advanced in synch with the strengthening dollar as record volumes of gold had to be stored to respond to the 13moz worth of new ETF demand. Then, in September, the gold option volatility skew suddenly flattened, the market went short gamma and – most unusually – never corrected after record increase in net long Comex positions. The goal posts of this market had shifted.


Investment demand is a game changer. Just witness the spectacular success of the new platinum ETFs in the United States since the beginning of 2010. In just two weeks, the market added the equivalent of 30% of last year’s global ETF demand… The picture for palladium is even more dramatic. There is little doubt that the autocatalyst and jewelry demand will have to respond to new price range and the PGM market may be testing how far the spread tolerance can go between the various market participants.


Platinum has a track record of taking some shine off gold. The market is about a tenth of the size of the gold market and the white metal lives a constructively schizophrenic life as an industrial and investment product at the same time. Although precious metals also tend to affect each other’s fortunes, an argument could be constructed on the basis of anecdotal evidence that the PGM ETF rush has led to some ‘gold fatigue’ among investors wobbling unsteadily into 2010.

But the clues to gold’s fortunes in 2010 have to be sought elsewhere. Yes, ultimately, gold market specific expectations will play the determining role – expectations surrounding central banks’ intentions, further growth of investment demand, recovery (or not) of Indian jewelry demand and the liquidity of the secondary market. Yet, I would argue that some of the main drivers of the gold market will come from the outside – determined by the broader risk perceptions, the shifts in the currency market, the anticipation surrounding relative interest rates and the bond market performance. Here is a short list of signals which may have consequences for the gold market.

1. Pay a close attention to the decisions surrounding the phase out of qualitative easing in the US. Although Bank of England has already begun to sell corporate bonds, the exact exit by the US monetary authorities remains uncertain. Any indication that the market could benefit from a significant drop in liquidity could be damaging to commodity market and to gold.

2. Watch the spread between US and Japanese 3-month Libor. Although carry trades are notoriously under-reported, there is little doubt that the spell of ultra-weak dollar since last summer correlated with the 3-month Libor falling below the levels of two classic funding currencies – JPY and CHF (Swiss National Bank has since intervened in the markets to weaken the currency). Any indication that the short end interest rates recover in the US could strengthen the dollar. And when it happens – while you may not necessarily be tempted to sell your gold jewelry or knock out your gold teeth just yet – you’d do well buying Japanese stocks.

3. Follow inflation-linked bonds. Any indication that US TIPS offer 2% or higher would mean a global recovery and possibly further inflationary pressures. How gold recovers will depend on market expectations for real rates going forward.

4. Further intervention by emerging markets in foreign exchange markets. Towards the end of 2009, emerging markets spent $150bn strengthening the dollar (and renminbi). Renewed bout of dollar buying would be gold-negative, ceteris paribus.

5. Treasury market balance in government budget deficit countries – not least in the US, UK, Japan and Euroland. The irony of 2010 is that the countries with the highest debt/GDP also enjoy the highest sovereign debt rating. But the demand for $4 trillions of new issuance from the G7 nations will depend on the appetite for other funds, velocity of money and inflation expectations. Any indication that Central Banks are reluctant to foot the bill could lead to rate spikes, affecting real interest rate – to which gold remains eminently sensitive.

These five signals are not mutually exclusive. It is also important to keep in mind that many of the arguments could function counter-intuitively. With 36% of investors based overseas, a US bond sell-off could initially be damaging for the dollar, yet the resulting increase in yields could dampen interest in commodities, including gold. On the other hand, an intervention by ECB to weaken the Euro (now less likely) could initially help the dollar, but the long-term effects would be liquidity-boosting – and therefore positive for risk assets and commodities.

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Tags: ETF, FX, GFMS, gold price drivers, interest rates, Libor, platinum, Treasury market