Made in China: The Demand Driving Gold ETF Performance

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By Christian Magoon
CEO, Magoon Capital

 

Gold ETF investors have experienced gains of around 25% over the last year. In fact the leading physical Gold ETFs, GLD and IAU, have gained over 140% during the last five years. Here's the performance chart from GoldETFs.biz showing a variety of performance periods.

 

 

In contrast, the S&P 500 ETF (SPY) has gained just 3.6% over the last five years. Here's the SPY performance chart from stockcharts.com.

 

 

The vast difference in performance between the S&P 500 and gold boils down to simple supply and demand. Gold is in more demand, and in shorter supply, than shares of the S&P 500. So who is driving that demand lately?

The results are in as The World Gold Council just released their Gold Demand Trends Report for the entire year of 2011 and China stands out. Gold demand in Greater China increased by 54% from 2010 to 2011, not bad for the second largest consumer of gold behind India. Due to rising incomes in China and the corresponding growth in gold jewelry and investment demand, China is projected to become the number one consumer of gold in 2012. So yes, we can now say the largest amount of gold demand will be made in China.

China has a variety of reasons to buy gold. First as a hedge against inflation given its growing economy. Second as a hedge against the U.S. dollar denominated assets it owns within its central bank. Finally, China - like India - values gold culturally which creates above average demand for physical gold, in the form of jewelry. Jewelry, by the way, is still the largest use of gold followed by investment in coins, bars and ETFs.

So as China surpasses India as the leading gold consumer, could a slowdown in China mean a pullback in gold prices? A quick comparison of the broad based China ETF, YAO, and the largest physical gold ETF, GLD, may hold some answers. Here's the performance chart.

 

 

Both YAO and the largest China ETF, FXI, have similar directional performance in relation to GLD.

From the chart above, it appears the ETFs have become more closely correlated in directional movement since the last half of 2011. While this is a short period of time, it is interesting to note that the increased emergence of China as a gold buyer coincides with this pattern. Indeed, this is a dynamic that will need to be examined more closely going forward.

Future sentiment on gold prices appears to be bullish as demand for gold by dominant growth engines like China and India is expected to rise. In the meantime, investors across the world view gold as a safe haven, especially during uncertain times in the Middle East and Europe. While the U.S. Dollar has competed with gold for "risk off" assets in the short term, the looming U.S. budget deficit will eventually need to be addressed and is likely to weaken the dollar, boosting gold. For now however it appears China is in the fast lane to dominate demand in yet another commodity, gold. Whether this changes the price behavior of gold and the ETF products that track it remains to be seen.



The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of The NASDAQ OMX Group, Inc.



This article appears in: Investing , ETFs , Economy

Referenced Stocks: GLD , IAU , SPY

Christian Magoon

Christian Magoon

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