The search for safety fuels a rush to buy gold

AS THE euro crisis simmers on, investors are rushing to stock up on physical gold in the search for a safe hold of value. Gold prices spiked to record highs in May, reaching $1,249 or £840 per ounce. Castlestone Management’s Angus Murray has even suggested a rise to $1,400 in the short-term and a trend towards $2,400 per ounce by 2020 due to “ongoing uncertainty in the sovereign debt markets, devaluation of money and geopolitical risk”.

One marked difference between recent rises and previous demand spikes is the existence of physically-backed exchange-traded funds (ETFs). Inflows into gold-backed ETFs have surged in recent years (see chart) and particularly since January as the Eurozone has failed to show definitive progress in resolving its debt issues. Purchases of gold-backed ETFs now outstrip those of physical gold coins and bars.

ETF Securities’ Nicholas Brooks says: “Over the past 12 months we’ve seen about $3bn go into our physical-backed gold ETFs, which is the largest rise we’ve seen in a 12 months period ever.” As a measure of how much the most recent crisis has weighed on the market, $1.3bn out of that $3bn has flowed in during the last two months alone.

Gold-backed ETFs have only been around since 2003 but have become increasingly popular because many institutions, such as American mutual funds, are banned from directly owning assets. As Bullion Vault’s head of research Adrian Ash highlights, by investing in shares backed by gold, they can take advantage of “a kind of reverse alchemy – turning gold into a securitised financial asset that enables financial institutions to gain exposure to the cash price of gold whereas previously they had to enter the derivatives market”. So while companies such as ETF Securities do cater to retail consumers, they are geared more towards the 80 to 90 per cent of their customers who are institutional investors.

Institutions are increasingly prepared to pay ETF fees for exposure to gold because of growing worries about the economy. Since last year, even central banks, historically net sellers of gold, have become net buyers. Although central banks are cagey about their gold purchases, there are rumours that South Korea and China are stocking up, with China able to avoid the international market by buying internally from its own ample gold mines.

This year’s gold rush is also markedly more serious than the spike in gold price at the end of last year. Although gold rose to $1,227 per ounce in December 2009 after the announcement of a large purchase by the Reserve Bank of India, it was mainly on the back of speculators seeking to ride a rise for short-term profit.

As Ash highlights: “This is fundamentally a more sustainable and physically-driven move in the price of gold than it was in December Gold and gold futures are different asset classes – they might be based around the same price but in terms of what people are looking for when they buy them, they are very different. If you’re trading in futures you’re riding the safe haven, buying on leverage with very little money down. If you’re doing it in physical gold, you’re doing it because you want the gold.”

Ash argues that May’s price rises are therefore the start of a longer-term upward trend for gold as investors flee the world’s second-biggest reserve currency, the euro. And if the spectre of debt and devaluation continues to haunt Europe – and the world – the rush for gold will only gather pace.