Gold Bullion Securities - Physical attraction

Given that the largest precious metal industry gathering took place last week in Berlin, it was fitting that the price of gold set a new high.  Those who are crying bubble are failing to recognise that the more recent high of US$1330 per ounce is still some way short of the 1980 high on an inflation adjusted basis. 

One of the most notable developments in the gold story is the surge in investment demand through ETF’s such as Gold Bullion Securites (LON:GBS) .  Whilst holding shares in gold mining companies provides the obvious leverage, holding physical gold as is the case with GBS ensures that investors are exposed to gold in a space isolated from the vagaries of equity markets.

This securitisation of bullion overcomes a number of issues that have previously arisen from investing directly in gold. Firstly, the bullion is held on trust to ensure that holders of GBS beneficially own the gold and not just a promise to pay in gold. Uniquely identifiable bars of gold are "allocated" to the trustee and beneficially belong to the investor. The gold held in the account is physically segregated from other metal held in the vault, and is not lent out and does not involve any derivatives. Secondly, the underlying liquidity of the shares is determined by the gold market so that GBS will always trade at or around net asset value.

The Daily Price formula for GBS is the spot gold price multiplied by one tenth of one ounce, less the management fee of 0.4% per annum.  As of the 01st October, assets under management (AUM) at GBS stood at US$5.35 billion and in terms of volume, GBS holds 4,077,635 million ounces.

Recently released data from the World Gold Council (WGC) illustrates the rise to prominence of investment demand for gold. During the second quarter of this year investment demand for the yellow metal (534 tonnes) overtook jewellery demand and ETF demand posted a huge 414% year on year increase; the quarter on quarter increase was significantly higher. Having seen strong inflows in August and September we would expect a continuation into the third quarter.

The WGC also reported robust jewellery demand for this year’s second quarter (409 tonnes) which was extremely encouraging given the rise in price and the vulnerability of the global economy. The global growth engines of Asia, India and China, were the main players with the former accounting for 123 tonnes, 2% lower than last year in terms of volume but a massive 20% higher in value terms. Chinese demand followed a similar pattern with volume demand increasing 5% year-on-year to 75 tonnes; the increase value terms was 35%.

Whilst increased investment and jewellery demand are encouraging enough, the recent shift in behaviour in the attitudes of central banks provides further cause for optimism.

The announcement this week from the Bundesbank that Germany will dispose of just 6.5 tonnes of gold during the coming 12 months is indicative of a shifting trend. Last year the signatories of the Central Bank Gold Agreement between them sold just 6.2 tonnes of gold, a far cry away from the near 500 tonnes sold between Septembers 2004 and 2005.

Not only are central banks not selling, but many are buying. Across the developing world faith in the US dollar is dwindling and central banks of all sizes, from Mauritius to Russia are continuing to look to diversify their holding of US dollars into gold. 

Gold continues to blaze a trail as fears over a double dip global recession have seen the yellow metal’s safe haven status come to the fore. The apparent solution, printing money, is simultaneously causing concerns over high inflation in the future, providing investors with further cause to jump into gold.

This report was produced by Senior Research Analyst Aamer Nawid.