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(Wallace Refiners) – Expectations for a faster-than-expected recovery for the global economy and a sharp rise in bond yields took a significant toll on the gold market as investors fled from their gold-backed exchange-traded funds (ETF).
According to the World Gold Council’s latest report, holdings in gold-backed ETF declined by 84.7 tonnes last month, a drop of 2% compared to January.
This is the third time in four months that the gold market has seen outflows in ETFs. The World Gold Council noted that global assets under management currently stand at 3,681 tonnes, the lowest level since June.
The drop in ETF demand came as the gold market saw its worst monthly price decline in four years, falling 6.5%.
“From a performance perspective, this is an unusual start to the year. Over the past two decades, January/February has typically been the strongest two-month period during the year,” the analysts at the WGC said.
Along with the weaker price, the WGC noted that the gold market’s global trading activity dropped by 12%.
While the latest trading data paints a grim picture of the gold market, the WGC said it’s not surprising that the yield on U.S. 10-year notes holds near a one-year high.
“Over the past year or so, we have highlighted that lower interest rates resulted in a reduction in the opportunity cost of holding gold. Conversely, as rates move higher, the yields on bonds become more attractive creating a headwind for the price of gold,” the analysts said. “Gold’s sensitivity to interest rates has increased by more than four-fold during the past year, and the movement in interest rates alone explains up to 40% of gold’s performance over the same period.”
Although bond yields have moved sharply higher since the start of the new year, the analysts at WGC note that real yields are still extremely low.
“Our analysis shows that gold can still perform well when interest rates are below 2% in real terms, well below their current level,” they said.
Gold’s lackluster performance so far this year has led to an increased concern that if record gold holdings in ETF continue to decline, it could generate a tidal wave of selling, similar to what happened in 2013. A 36% decline in gold holding caused the biggest selloff in 30 years for the precious metal seven years ago.
However, in a recent interview with Wallace Refiners, Adam Perlaky, senior research analyst at the WGC, said that the gold market had changed significantly in the last seven years. He noted that ETF demand is now more diversified and global.
Although investors are focusing on better-than-expected growth forecasts, the WGC said inflation remains a growing concern and will keep real interest rates low for the foreseeable future.
“Inflation expectations appear to be rising and a commodity-led ‘reflation’ appears to have begun. Broad-based commodities have shown strength, which often occurs as markets enter inflationary periods,” the analysts said. “Historically, gold has tended to underperform a commodity-led reflationary period in the first six months but has generally outperformed in the subsequent six to 36 months.”
Looking at regional data, North American funds led the way in outflows, with gold holding declining by 71.2 tonnes. European-listed funds saw outflows of 23.8 tonnes; however, Asian-listed funds increased by 10.6 tonnes.
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