John Paulson’s Gold Bet Signals ETF Rout Ending

November 19, 2013 at 08:50

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Gold investors who are worried by the downward spiral of prices for the yellow metal over the past year have focused their attention almost entirely on guessing when the US government will start to taper down its monthly $85bn (£53bn) asset-purchase programme.

As the US economy has gradually improved, investors have unwound gold investments over the past year, ending a near-15-year rally in the precious commodity. At their peak, prices nudged just above $1,900 an ounce, back in the dark days of 2011, when gold provided the ultimate safety blanket against global economic turmoil.

Despite the slight relief provided late last week when the market perked up following the broadly dovish statements from US Federal Reserve chairman nominee Janet Yellen, gold prices are expected to remain volatile.

The pace of the selldown has continued this year, with gold falling 23pc to around $1,287 an ounce, as investors in gold-linked exchange traded funds (ETFs) headed for the exit.

During the gold bull market, ETFs — which aim to track the price of securities or commodities traded across different indices — had offered investors the safest way to bet on gold. The investment vehicle’s popularity was also boosted because they conveniently avoid having to store physical gold, a costly and sometimes risky undertaking.

The latest report by the World Gold Council has placed much of the blame for the malaise hanging over prices on a structural shift between East and West that is under way.

As western investors in ETFs have cut their positions, retail buyers, predominantly in Asia and the Middle East, have continued to pile in to the market, but not in sufficient numbers to significantly halt the slide. However, most analysts agree that without this support for demand, the drop in gold’s value could have been much worse.

In the third quarter, demand for gold fell by 21pc year-on-year, to 868.5 tonnes, led almost entirely by outflows from the ETF sector, according to data compiled by the World Gold Council and Thomson Reuters.

By the end of September, almost 700 tonnes had exited ETFs. Most of this physical demand for gold was absorbed by central banks and consumers buying minted coins and jewellery.

Demand for jewellery over the past nine months, which mostly comprises metal already in circulation, has hit a historical high of 2,896.5 tonnes, according to the council’s Gold Demand Trends report.

Tough new government legislation aimed at cutting gold imports and moderating retail buying of it in India had mixed results, with consumer demand still growing by 19pc in the past nine months. Traditionally, gold demand in the subcontinent has been underpinned by the dowry system, whereby marriages are sealed with lavish and elaborate gold jewellery.

In parts of rural India, many families start hoarding gold as soon as a baby girl is born, to endow a marriage, and banks have increasingly underwritten these purchases.

Measures introduced earlier this year by the Reserve Bank of India to restrict access to gold loans, which it was feared were driving debt-fuelled speculation on the metal, have had mixed success. In addition to restrictions on loans, in July the government in Delhi introduced tough measures that tied gold bullion imports to a fixed level of re-exports.

But, according to the World Gold Council, the effect of these changes has been limited by India’s porous borders.

Despite the risks that continue to weigh on gold prices, some heavyweight investors are persisting with the commodity as a hedge against risk. Contrary to the prevailing trend, billionaire hedge fund manager John Paulson has held his current level of exposure to the world’s biggest gold ETF after initially cutting bets on the commodity earlier in the year.

His decision to stick with gold may be a sign for average investors to step back in.