16/8/2013: US Mint gold sales: H1 2013

In the previous post I covered July 2013 monthly sales figures for US Mint Gold Coins. As promised, here is a more stable trends analysis using H1 aggregates from 1987 through June 2013.

In H1 2013, US Mint sold 629,000 oz of coinage gold, marking the 5th highest ranked H1 in sales terms since H1 1987. Year on year, H1 2013 sales were up 86.1% and relative to crisis period average, sales were up 22.0%, while relative to the pre-crisis period (2001-2007) H1 2013 coinage gold sales were up 261.5%. For comparison, historical H1 average sales are currently at 336,520 oz.

In H1 2013, US Mint sold 1,088,500 coins, marking the third busiest H1 sales period since 1987. For comparison, historical average sales for H1 are at 592,615 coins.

In terms of average gold volume per coin sold, H1 2013 came it at 0.578 oz/coin, which is relatively moderate, given the historical average of 0.577 oz/coin.

Chart below to illustrate the above:

Chart above shows that both coins sales and oz sales of coinage gold remained in H1 2013 on the upward trend established since 2007 and the overall 2009-2013 activity for H1 period remains at post-1999 highs. There is little indication of any serious long-term slowdown in demand for US Mint coins in the data and H1 2013 strengthened the trend away from such moderation. The correction sustained over 2011-2012 has now been more than reversed and H1 2013 numbers in terms of coins sold is sitting comfortably above previous post-1999 maximum attained in 2010.

At the same time, demand for coinage gold (oz sold), while partially correcting upward in H1 2013 remains below the local maxima set in 2009-2010.

The above is consistent with restricted buying-on-the-dip behaviour, with some upward momentum being sustained by considerations other than price movements. This is further supported by changes in correlations between sales and the spot price of gold (average of closing monthly prices in USD):

• For price vs oz correlation, correlation between H1 1987 - H1 2012 stood at +0.22 and this rose to +0.29 for the period H1 1987 - H1 2013, implying (recall that price fell for H1 2013 to USD1,484.50/oz compared to H1 2012 at USD1,664.00) some limited buying-on-the-dip behaviour.
• For coins sold vs price, correlation H1 1987 - H1 2012 stood at +0.04 and this rose to +0.11 for the period H1 1987 - H1 2013, also implying limited buying-on-the-dip behaviour.

It is worth noting that H1 2013 figures were driven largely by January )month 1 of Q1) and April (month 1 of Q2) sales. This dynamic did not replicate in July (month 1 of Q3), so we should tread cautiously in expecting robust continuation of the H1 sales in H2.

16/8/2013: US Mint gold sales: July 2013

It has been some time since I updated the data on sales of US Mint Gold Coins, so let's take a quick run through the data for July 2013.

• US Mint gold coins sales in July 2013 stood at 50,500 oz, dow 11.4% m/m (though there is little point looking at monthly figures which can be volatile) and up 65.6% y/y. The sales were close to historical average at 57,239 oz and below the crisis period average (since January 2008) of 88,694 oz.
• US mint sales of coins in July 2013 stood at 90,000 coins, down 20.4% m/m and up 97.8% y/y. This compares agains 100,286 coins sold on average per month over historical period and 124,731 coins sold on average per month over the crisis period.
• Average volume of gold sold per coin in July 2013 stood at 0.561 oz/coin, which is 11.2% ahead of June 2013 and 16.3% behind July 2012. In historical comparatives, July sales were behind 0.59 oz/coin monthly average over the historical period and well behind 0.77 oz/coin average for the crisis period.
• 24mo rolling correlation between volume sold (oz) and gold price (end of month spot price) stood at 0.009 in July 2013, up on -0.045 in June 2013 and ahead of -0.09 average rolling correlation for the historical period covered by data, but virtually identical to the 0.01 average rolling correlation for the crisis period. In basic terms, the zero correlation between gold coins sales and gold spot price remained intact in July 2013.

Charts to illustrate:

Overall, analysis above confirms a short-term trend toward increased demand for gold coins, driven by changes in prices. This trend is more directly evident in 6mo sales data (next post). In total coins sales, there is a nice reversion to the up-sloping trend (first chart above), while oz/coin sold remains below the longer-term up-sloping trend line, potentially reflective of speculative purchasing running at more subdued volumes (second chart). Per third chart, there is a clear negative correlation between demand for coinage gold and the price of gold, suggesting some 'buying-on-the-dips', although this correlation is weak (last chart above) and is getting weaker (in absolute terms). There is a long-term trend toward positive (or at least much less-negative) correlation between the price of gold and coins sales.

Tune in for the H1 2013 cumulative data analysis next.

2/4/2013: US Mint Gold Coins vs Gold Prices

In the previous post I covered some Q1 2013 trends in US Mint gold coins sales and mentioned correlations between spot price of gold and volume of coinage gold sold. Here's a bit more beef on the latter.

As charts above clearly show, there is not much of a statistically significant relationship between price of gold and volumes of coinage gold demanded, neither in levels terms, nor growth terms. Which, of course, strongly suggests that the demand for coinage gold is based on longer-term considerations than those underpinned by simple price reactions.

Looking at H1 data over the same time horizon confirms the main observation:

There is zero relationship in smoother data (H1 cumulated) between demand for coinage and price of gold, while there is a relatively weak positive correlation between demand for gold content per coin purchased and the price of gold.

Key point here is that there is absolutely no hard evidence that gold coins demand is bubble-prone or bubble-driven.

2/4/2013: US Mint gold sales: Q1 2013

Q1 2013 data for gold coins sales by US Mint is out and is worth a look. Here are some top trends:

Per chart above, number of US Mint coins sold in March 2013 declined to 103,000 compared to 155,000 in February. Controlling somewhat for seasonal changes, y/y number of coins sold rose 3.52% from 99,500 in sales in March 2012. Looking at Q1 totals, Q1 2013 sales added to 533,500 coins, up 39.3% on Q1 2012, 10.57% on Q1 2011 and 96.86% on Q1 2010. Healthy uplifts against generally flat-trend prices. And, crucially, coins sales do not appear to be tracking 'risk-on' and 'risk-off' signals from equity markets. As I always maintained, coins sales have much more to do with steady risk-averse savers than with speculative buyers.

Chart below details relationship between volumes of gold sold via US Mint coins and price of gold (monthly final). In terms of volumes sold, March 2013 clocked sales of 62,000 oz, down from 80,500 in February 2013, and down 0.8% on March 2012 (62,500 oz). In quarterly totals, Q1 2013 came in at 292,500 oz and this was up 38.95% on Q1 2012, down 2.34% on Q1 2011 and up 7.93% on Q1 2010. In other words, much steadier demand growth in volumes of sales was also broken in 2013.

Meanwhile, price of gold rose 1.21% m/m in March and slipped 3.29% y/y. (More on correlations below).

The following chart details trend in average gold content per coin sold (oz/coin): in March 2013, average gold content stood at 0.602 oz/coin, up on 0.519 oz/coin in February 2013 and not far off from the 0.628 oz/coin in March 2012. However, overall trend remains relatively flat at around 0.65 oz/coin since mid-2006. Longer term trend is gently upward, indicating that over time, investors and savers started to allocated slightly more of their investable savings into coinage gold.

 Chart below shows correlation between volumes of coinage gold sold and gold price:

Two things worth noting in the above:

1. Since approximately Q2 2012 we are experiencing steady upward momentum in 12 months rolling correlations, and these are rising toward +0.5. This trend was confirmed in March 2013 and it is consistent with 24mo rolling correlations, but is still far off on 36mo or 50mo rolling basis.
2. Linear long-term trend is also upward and is now in the positive correlation territory. This can potentially suggest that gradual financialisation of the gold markets in general is having a long term impact on gold's shorter-range hedging properties, since positive correlation is consistent with higher propensity of 'buy-on-dips' and 'book profit' behaviour. However, as 60mo chart shows below, we are still in solid hedging territory for now when it comes to longer investment horizons. Furthermore, correlations trends are negligible in size. So something to watch in the future and to blog on next... stay tuned.

Chart with 60mo rolling correlations

7/1/2013: Falling speculative investment interest in gold

In two recent posts I covered US Mint sales data (annual and monthly) for gold coins. The core theme of both was the return to fundamentals in demand as signaled by sales volumes. Such a return, of course, is the flip-side of the retrenchment by speculative investors. Here's a chart from BCA from November 2012 showing just that process working through:

Note: Disclosure in the first link above.

5/1/2013: US Mint December 2012 sales

In the previous post (here), I looked at the annual data for US Mint gold coins sales. Here, let's take a quick look at the shorter-term, monthly trends and dynamics for December 2012.

Following a robust monthly rise in sales of coins by oz (weight) totals to 136,500 oz in November, December sales moderated to 76,000 oz (down 44.32% m/m), still posting a healthy 16.92% increase y/y. Compared to historical average of 56,346 oz the sales are still up, although December 2012 is below 87,717 oz average sales for the crisis period (since January 2008). However, while difference to historical (1987-2012) average is significant statistically, it is not significant relative to crisis period average. Furthermore, 6mo MA is at 68,250 which is well below the December sales levels.

For those thinking of a 'big fall-off in sales', December 2012 marked the highest volume (by weight) of sales since December 2009 and the fourth highest volume since January 2000.

In terms of number of coins sold, December 2012 came in at 82,000, or 52.74% down on November robust sales of 173,500, but monthly sales were up 26.15% y/y. Compared to historical averages, December 2012 sales are statistically indifferent from historical average sales of 98,758 coins per month, and from crisis-period average of 119,642. 6mo MA sales are at 93,500, ahead of December sales, while H1 2012 average sales were at 93,750, also well ahead of December 2012 volumes.

The relative moderation in the number of coins sold compared to the trends in the volume of coinage gold sold (oz) can be explained by the increased oz content of average coin sold. In terms of oz/coin sold, December 2012 sales stood at 0.927, well ahead of 0.787 in November, posting the highest gold content reading for any month since December 2011. Historical average content is at 0.590 oz/coin and crisis period at 0.790 oz/coin, both statistically significantly lower than December 2012 figure.

Charts and dynamics:

As above clearly shows, the historical trend is upward sloping and the current reading is comfortably at the trend levels both in terms of 6mo MA and actual level reading for December 2012.

The chart above shows contemporaneous negative correlation in price of gold v volume of gold coins sales between September 2009 and April 2012, with exception of December 2010 - August 2010. This correlation has now been broken down and turned positive since April 2012 - a new sub-trend that remained consistent since then and was reinforced in December 2012 figures. Chart below illustrates this much more clearly:

A little more statistical 'beef' on these: 12mo dynamic correlation between gold prices and total gold sales via coins (total oz weight of sales) rose to +0.34 in December from +0.28 in November 2012, so declined prices (y/y) have been associated with some increase in demand. Recall that in November-December 2011, gold prices fell from $1,746 to $1,531, while in the same period 2012 they moderated from $1,726 to $1,657.50. December marked 4th consecutive month of positive 12mo dynamic correlations. Historical 12mo dynamic correlation of +0.17. Looking at longer-range correlations, 24mo dynamic correlation in December 2012 stood at -0.23 against the historical average of -0.10 and up (in absolute terms) of -0.19 in November.

Per average coin sold gold content:

As mentioned above, December 2012 sales were characterised by a substantial increase in average gold weight of coins sold which is running well ahead of the historical (upward sloping) trend. More significantly, this year sales fell below the historic trend in 6 months out of 12. Hence, neither trend direction, nor current deviation from the trend are indicative of any severe downward demand pressures.

Overall, sales dynamics show that since February 2012, volumes of sales in oz have recovered nicely back to their historical trend (upward sloping) and are currently running above the January 2000-July 2008 averages.

Note:
Historical, long-term relationship between gold prices and demand:

While December 2012 observation is to the downside of the trend, it is clear from the picture overall that changes in gold prices during a given month have statistically no discernable relation to the demand for gold via US Mint coins sales. This simply confirms the nature of fundamentals driving demand for coins as discussed in my previous posts on the issue (see previous post linked above for one such link).

5/1/2012: US Mint Gold Coins Sales: 1986-2012 data

The readers of this blog would be familiar with the exclusive time series on US Mint sales of Gold coins that I have maintained for some years now. With December 2012 sales finalised, it is time to update the annual and monthly data analysis on these.

Here is the analysis for January 2012 - to open the year - that predicted 'return to fundamentals' theme for coin sales. And here is my article for Globe & Mail on what fundamentals relate to gold coins sales.

I am happy to note that my prediction of moderating trend in speculative buying and restoration of stronger link to long-term behavioural demand and savings fundamentals has been confirmed through 2012.

Looking at annual data for 2012 (note: subsequent post will provide more shorter-term dynamics analysis for December data), first in weight terms:

• In 2012 the US Mint sold 747,500 oz of gold in form of coins, down 25.25% y/y, with demand for coinage gold declining below 2008 levels of 860,500, but well-ahead of the 2005-2009 average annual sales of 640,800 oz per annum.
• In terms of longer-term averages, 1990-1994 average was at 384,050 oz, 1995-1999 average at 1,047,800 oz, 2000-2004 average run at 386,550 oz, 2005-2009 average at 640,800 oz per annum and 2010-2012 average is currently at 989,333 oz per annum. 
• 2012 was the 10th highest demand year in history in terms of volume of gold coins sold in oz of gold, with series covering 1986-2012 period. In other words, 2012 was not a good year for Gold Bears and for Gold Speculators alike. This doesn't make it a great year for Gold Bulls, but, given that the average annual gold price in 2012 stood at $1,678/oz - ahead of any on the record and up  7.0% on 2011 - it does appear to have been another year when fundamentals seemed to triumph over shorter-term psychosis. 
• My annual forecast for sales in 2012 was 694,050, which means that simple dynamic trend of moderating sales expectations based on previous years' price effects was bearish.

In terms of number of coins sold:

• US Mint sold 1,123,500 coins in total in 2012, down 21.27% on 2011. The demand for actual coins was at the levels compatible with 2008 when the Mint sold 1,172,000 coins and well ahead of all annual sales in 2000-2007 period.
• In terms of longer-term averages, 1990-1994 average was at 637,620 coins, 1995-1999 average at 2,246,300 coins, 2000-2004 average run at 738,700 coins, 2005-2009 average at 955,800 coins per annum and 2010-2012 average is currently at 1,397,167 coins per annum. In other terms, current sales are annually bang on at the annual average for the last 8 years.
• 2012 ranks as the 10th most successful year for coins sales in terms of the number of coins sold, confirming my view in the third bullet point above regarding sales of coinage gold in oz.
• My forecast for 2012 sales was at 1,21,223 coins - a much closer call than on oz of gold sold via coinage, suggesting that the demand remains closely driven by long-term dynamics.

In terms of both - sales in coins numbers (1,123,500 coins) and oz (747,500 oz), 2012 results stand in close comparative to the historical averages. Historical average (1986-2012) for coins sold is 1,261,170 and for oz of gold sold through US Mint coins is at 717,343 oz.

In terms of average gold content of coins sold:

• 2012 average coin sold by the US Mint contained 0.665 oz of gold per coin, down slightly on 0.701 oz/coin in 2011 and well-ahead of the historical average of 0.574 oz/coin.
• 2012 ranks as the fifth highest year on record in terms of average oz/coin sales.

Charts:

Historical dynamics:

As charts above illustrate, all time series have shown convergence to the long-term upward trend:

• There is, so far, no overshooting of the trend to the downside - something that could have been expected if demand for gold coins was showing speculative bubble deflation dynamics or post-bubble correction, although, of course, we cannot say with 100% accuracy that this is not going to materialize with some lag.
• There is no acceleration in the convergence trend in 2012 or since convergence began in 2009.
• This episode of convergence is shallower (in terms of annual speed to target) than in 1997-2002 period and 1986-1991 period.

Historical correlations:

• In terms of historical correlations, the following matrix holds, showing overall zero to low level negative correlations between prices and demand for coins and coinage gold:

The above, of course, implies that given moderating price increases in gold (+7% for annual monthly average in 2012 compared to 22.21% rise in 2011, 25.61% in 2010, 11.44% in 2009 and so on), we can expect a slowdown in overall oz and coins volume demand, which can lag price changes. This is exactly what appears to have taken place in 2012.

As before, I remain comfortable with the 2012 trend and am looking forward toward more stabilised demand dynamics in 2013, with volume of sales declining in 2013 to ca 500,000 marker in oz terms and 850,000 in coins numbers terms, assuming no major volatility in gold price and in line with continued stabilisation in the world economy.

Disclaimer:
1) I am a non-executive member of the Heinz GAM Investment Committee, with no allocations to any specific individual commodities
2) I am long gold in fixed amount over at least the last 5 years with my allocation being extremely moderate. I hold no assets linked to gold mining or processing companies or gold ETFs.

3) I receive no compensation for anything that appears on this blog. Everything your read here is my own personal opinion and not the opinion of any of my employers, current, past or future.

13/12/2012: Some thoughts on gold

Tonight's Prime Time program covering gold is undoubtedly one of the rare occurrences that this asset class got some hearing in the Irish mainstream media. Which is the good news.

Not to dispute the issues as raised in the program, here are some of my own thoughts on the question of whether or not gold prices today represent a bubble.

A simple answer to this question, in my opinion, is that we do not know.

Short-term and even medium-term pricing of gold (in any currency) is driven by a number of factors (fundamentals), all of which are hard to capture, model and value.

For example, currency valuations forward suggest that gold is unlikely to experience a sharp and protracted correction in the US dollar terms, if you believe the Fed QE4 is likely to persist over time. In euro terms, potential for devaluation of the euro implies pressure to the upside to the gold price. Yen price is also likely to play longer-term continued devaluation scenario. Things are less certain when it comes to Pound Sterling price… and so on. Here's just one discussion on one of the above effects: http://soberlook.com/2012/12/precious-metals-hit-by-evans-rule.html?utm_source=dlvr.it&utm_medium=twitter

Another example: drivers for prices on demand side that include rather volatile regulatory conditions in the major gold demand growth markets, such as China and India.

In short, things are much more brutally complex than the PrimeTime programme allowed for.

The reason for this complexity is that gold acts simultaneously (as an asset) in several structural ways:
1) as a simple bi-lateral long term hedge for inflation, equities and currency valuations
2) as a medium term (albeit not entirely persistent) hedge for some asset classes (e.g. equities)
3) as a short term speculative instrument to some investors
4) as a backing for numerous and large volume ETFs
5) as a benchmark backing for numerous and relatively large volume synthetic ETFs
6) as a store of value
7) as a risk management tool for complex structured portfolios
8) as a bilateral safe haven against equities and bonds, political and economic risks, systemic financial markets risks, etc.

These relationships can be unstable over time, can require long time horizon for materialization and are 'paid for' by assuming higher short term volatility in the price of gold. That's right - while PrimeTime contributors spoke about gold price 'correcting' or 'bubble bursting' none seemed to be aware of the fact that if you want to get something you want (hedging and safe have properties being desirable to investors), you should be prepared to pay for it (price volatility seems to be a good candidate for such cost of purchase).

No matter what happens in the short- to medium- term, gold is likely to remain the sole vehicle for the store of value and risk hedging over the long-term. It did so over the last 5,000 years or so and it will most likely continue doing so in years ahead. This property of gold is well established in the literature and is hardly controversial.

There is one caveat to it - due to instrumentation via ETFs, there are some early (and for now econometrically fragile) signs emerging that some of gold's hedging properties might be changing. More research on this is needed, however and only time will tell, so in line with PrimeTime, let's stay on the RTE side of Complexity Avoidance Bias on that one.

There is an excellent summary on what we know and what we don't know about gold by Brian M. Lucey available here:  http://ssrn.com/abstract=1908650 .

Last year I gave a presentation at the Science Gallery on some properties of gold, which is posted here: http://trueeconomics.blogspot.ie/2011/08/20082011-yielding-to-fear-or-managing.html .

Not to make this post a lengthy one, let me summarize my own view of gold as an asset class:

1. In my view, gold can be a long-term asset protection from the risk of expropriation, inflation, devaluations, and tail risks on political and economic newsflow side etc.
2. To me, gold is not a speculative (capital gains) instrument for the short-term and it should not be acquired in a concentrated fashion - buying in one go large allocations. Gold should be bought over longer period to allow for price-averaging to reduce exposure to gold price volatility.
3. Gold allocation should be relatively stable as a proportion of invested wealth - different rules apply, but 5-10% is a reasonable one in my view.
4. Of course, any investment portfolio (with or without gold) should strive to deliver maximum diversification across asset classes, assets geographies etc.

Disclosure: I have no financial interest in or any commercial engagement with any organization engaged in selling gold. Until December 1, 2012 I used to be a non-executive member of the investment committee of GoldCore Ltd and was never engaged on their behalf in any marketing or provision of advice to any of their current or potential clients.

9/5/2012: Carat, Stick, Gold, Council Estate. Boom!

This week, Irish Times have ventured to cover gold in an article titled “The carat and stick approach to investment".  

Please see my disclaimer at the bottom of this post.

We can debate the semantics of the Irish Times headline, but the ‘stick’ suggests some sort of compulsion for investors to purchase gold. 

In reality, few dealers in Ireland actually offer direct access to properly stored gold at an affordable margin. I have not seen any ‘Buy Gold, or Else...’ marketing campaigns, comparable in the force of conviction or compulsion to the tsunami of sell-side promotions unleashed onto Irish investors in property and banks shares in the recent past. Irish Times does not have a dedicated portal 'MyGold.ie' or a special 'Buy Gold' supplement where gold dealers can advertise their coins, nuggets, bars, etc. When gold is covered on the pages of the Irish business press, it is almost invariably painted in apocalyptic terms.

In-line with this tradition, the article opens on a horror story of a young couple living on a council estate, all their savings in gold, stored on-site. One has to wonder if Irish Times writings on, say, pet ownership always relay bone-chilling tales of killer pooches attacking unsuspecting elderly owners. One has to wonder, because a gold bar has about as high probability of ending up under the mattress in a council dwelling as an average retiree faces the threat of being mauled by a man-eating Chihuahua.

I actually agree with the article implied thesis that no investor should be advised to put all their savings into gold or any one specific asset or asset class. Such an atrocity of mis-selling should never befall a retail investor.

However, prudent risk management does imply, in my view, that investors should hold a relatively fixed percent of their invested wealth allocation in gold. Not for speculative reasons, but for risk hedging reasons to cover over the long run wealth volatility induced by other assets and the adverse effects of inflation.

Hardly a ‘stick’ approach.

There’s a point about Gold being a rollercoaster-styled investment vehicle compared to stocks and bonds, raised in the article. Indeed, gold prices show high volatility. Less so on the semi-variance side (downside) than on the overall variance side (downside and upside). And less on geometric weighting (that concern wealth preservation) than on arithmetic (the one that is more suited for short-term returns comparatives), but this is too nuanced for a newspaper article.

The Irish Times seems to be unaware of the ‘survivorship bias’. Over the time horizon glimpsed across by the article, many investments in stocks and bonds have gone in value from ‘hero’ to ‘zero’, as companies went bust, sovereigns and local issuers of bonds defaulted or restructured, currencies disappeared and hyper-inflation bouts have demolished the value of assets, banks deposits have been lost, and so on. Pesky gold ‘relic’ is still here.

There is a priceless moment in Simpsons where Montgomery Burns checks his ticker tape to discover his Confederated Slave Holdings has gone bust. On a more serious note, Nassim Taleb wrote books and academic peer-reviewed articles on the stuff. And Taleb also brings up the value of gold as a hedge against such risks.

Irish Times frequently quizzes serious economics luminaries from stockbrokers and real estate agents. And with clear disdain, the article references the opposite sort – the ‘pop economists’. Let's take a look at some of those using historical valuations / references for highlighting gold’s functions in the real world:

• Nobel Prize winner Robert Mundell recognizes the value of gold as inflation hedge, stating that “Gold will be part of the structure of the international monetary system in the twenty-first century.” Yep, there’s even a website for this sort of pop populism: http://robertmundell.net/economic-policies/gold/, where he is quoted saying that “When the international monetary system was linked to gold, the latter … established an anchor for fixed exchange rates and stabilized inflation. When the gold standard broke down, these valuable functions were no longer performed and the world moved into a regime of permanent inflation.
• Another pop economist is Professor Roy W. Jastram, University of California, Berkeley. His The Golden Constant shows how gold maintained its purchasing power over very long periods of time.
• Professor Steve Hanke of the populism-swept Johns Hopkins University is another one who argues in favour of gold standard currencies precisely because he believes that gold is a long-term inflation hedge.
• John Nash, an unscrupulous peddler of gold with a Nobel Prize medal around his neck (made of gold, note), has called for a gold standard, presumably to sell more gold bars to London Council flats inhabitants.

Yes, there is much of a debate going on the virtues and pitfalls of gold as an investment vehicle or a monetary base. Yes, both sides of the argument have serious research behind them. But that is not what the Irish Times article portrays. Instead of presenting a debate, or actual evidence on the dangers of over-investing in an asset class, the article draws an extremely selective depiction of reality framed in derogatory terms.

Meanwhile, the article description of various gold investment vehicles is incomplete, omitting, for example, the fact that some gold ETFs are synthetic, rather than physical gold-backed, and that some products available in the market allow to purchase gold on price-averaging basis, reducing exposure to price volatility.

A ‘rollercoaster’ investment vehicle that is gold is the only asset in existence that actually provides a risk hedge and a safe haven over long-term structural adjustments and short-term fluctuations across the majority of other asset classes, including stocks. If the Irish Times want proof of this, they can read research on the topic available on ssrn or repec or econlit. Professor Brian Lucey, researcher and lecturer Fergal O’Connor and myself are co-authoring on a database of studies on gold as an asset class, its properties, behavioural implications and empirical analysis, which is available at http://preciousmetalsresearch.wordpress.com/.

There is a priceless bit in the article on determination of an asset bubble. The author logic goes as follows: “In 2007, more than 80 per cent of the demand for gold was for jewellery and industrial use, while less than 20 per cent of demand was from investors. By 2009, this had changed dramatically. Investment demand had risen to 43 per cent of the total. The rise in demand from investors raises the question as to whether speculation is a key driver of the gold rally.”

This does a number of things:

•  It answers a question with a question.
•  It also suggests that investor demand is always speculative.
• It confuses speculation, investment and bubble formation. 90%-plus of equities (other than retained shares) and 100% of bonds are held by investors, and yet Irish Times does not call equities or bonds bubbles every day of the week.
•  It ignores the other side of the equation, what happens with the non-investment demand for gold.

Let me provide some more numbers:

Between 2002 and 2007, demand for physical use gold (jewellery, dentistry and technological) has declined on average at the rate of 1.5% pa, since 2008 through 2011 the rate of decline was -4.42%. At the same time, demand for gold bars and coins rose at 4.83% pa on average in 2002-2007 and at 41.93% pa on average in 2008-2011. Demand for ETFs-held gold, meanwhile, more directly instrumenting ‘speculative’ (or shorter-term) investments has 79.9% pa on average in pre-2007 period and at 5.14% pa on average in 2008-2011 (or crisis period).

Drama all around, unless you look slightly deeper into demand drivers.

Physical gold demand has been abating over the 2000s primarily due to diversification in jewellery demand away from gold (rise of prominence of platinum during the years of 2002-2007 and silver in the latter years, driven by tastes and price effects, plus recession-related income effects and tax and local currency considerations). A quick read through demand drivers analysis from the World Gold Council would help here.

In addition, it is wrong to classify sales of bars and coins as ‘speculative’. Behavioural studies suggest that sales of bars & coins are driven strongly by savers, rather than traditional speculative investors. These ‘savers’ are more often than not wealthier individuals (especially in the case of bars buyers) who tend to hold both instruments over longer horizon. Coins holdings are even less sensitive to price changes than demand for bars. For example, coins demand for US Mint Eagles has spiked around 1997-2000 with no reaction in the coins price. I doubt even the Irish Times would have spotted a bubble there. (chart).

These are not to be ignored, as roughly 20% of the investment gold demand is accounted for by coins and medals.

Lastly, one has to distinguish between speculative (capital gains-driven) investments and short-term risk management objectives (such as flight to safety or flight to quality considerations). These factors are hard to control for, but smoothing demand for investment gold in 2008 and 2011 – the two core years of the crisis, using historical trend suggests that the ‘hedging’ demand for gold to cover the spikes in markets volatility around the equities and sovereign crises peaks accounts for about 9-10% of total gold demand at the end of 2011.

A quick note below the post does some back-of-the-envelope illustration on price-demand links.

In brief, the issue of gold valuation is complex and very much open to the debate. I, personally, have no opinion on whether gold price today is a bubble or not. It might be, it might be at the beginning of the bubble formation or at the tail end of it. I have no idea. Nor do I have any idea where the gold price will be in 3 months time.

What I can say is what I keep repeating any time someone asks me about gold: gold is a wealth management tool suited for risk hedging and wealth preservation, not for chasing speculative gains.

Disclaimer:
1) I am a non-executive member of the GoldCore Investment Committee.
2) I am a Director and Head of Research with St.Columbanus AG, where we do not invest in any individual commodity.
3) I am long gold in fixed amount over at least the last 5 years with my allocation being extremely modest. I hold no assets linked to gold mining or processing companies.
4) I have done and am continuing doing academic work on gold as an asset class, but also on other asset classes. You can see my research on my ssrn page the link to which is provided on this blog's front page.

5) I receive no compensation for research appearing on this blog. Everything your read here is my own personal opinion and not the opinion of any of my employers, current, past or future.

6) None of my research - including that on gold - should be considered as an investment advice or an advise to buy or invest in any asset or asset class.

Note: using annual data we can look at the relationship between demand for gold by various types and prices. Chart below illustrates.

Three things are relatively clear: 

1. Between 2002 and 2011 there is a rather strong positive relationship between gold price and demand for bars and coins;
2. Between 2002 and 2011 there is relatively strong negative relationship between gold price and demand for physical use gold;
3. Between 2002 and 2011 there is relatively weak relationship between gold price and demand for gold by investment funds

Now, here's a question, if bubble in gold is to be traced to 'speculative' demand spikes in response to the price movement, why on earth would there be less of a relationship between price and the most speculative type of gold investment - the ETFs and more of a relationship between less speculative physical demand for gold and price of gold?

11/09/2011: What gold coins sales tell us about the 'bubble'

Here is the extended version of the article published by Globe & Mail on the topic of US Mint sales of gold coins.

Of all asset classes in today's markets, gold is unique. And for a number of reasons(i).

Firstly it acts as a long-term hedge and a short-term flight to safety instrument against virtually all other asset classes.ii Secondly, it supports a wide range of instruments, including physical delivery (bullions, coins and jewellery), gold-linked legal tender, gold-based savings accounts, plain vanilla and synthetic ETFs, derivatives and producers-linked equities and funds. All of these are subject to diverse behavioural drivers of demand. Thirdly, gold is psychologically and analytically divisive, with media coverage oscillating between those who see gold as either a long-term risk management tool, or a speculative investment, a "barbaric relic" prone to "bubble"-formation.

In the latter context, it is interesting to look closer at the less-publicised instrument - gold coins, traditionally held by retail investors as portable units to store wealth. Due to this, plus demand from collectors, gold coins are less liquid and represent more of a pure 'store of value' than a speculative instrument. Lower liquidity of coins is not driven by shallow demand, but by reluctance of owners to sell them when prices change. Gold coins are economically-speaking "sticky" on the downside of prices - when price of gold falls, holders of coins are not usually rush-prone to sell as they perceive their coins holdings to be 'long-term accumulations', rather than speculative (or yield-sensitive) investments. They are also "sticky" on the upside of prices - while demand is impacted by price effects (with generally higher gold prices acting to discourage new accumulation of coins), holders of coins are not quick to sell to realize capital gains, again due to entirely different timing to the holdings motives. Think of a person setting aside few thousand dollars worth in gold coins to save for child's college fund.

In general markets, classical bubbles begin to arise when speculative motives (bets on continued and accelerating price appreciation) exceed fundamentals-driven motives for opening new long positions in the instrument. Bubbles blow up when these tendencies acquire wide-based support amongst retail investors.

In late stages of the bubble, we should, therefore, expect demand for gold coins to falter compared to the demand for financially instrumented gold (ETFs shares and options). In the mid-period of bubble evolution, however, as retail investors just begin to rush into the asset, we can expect demand for coins to rise in line with demand for jewellery and smaller bullion. But we do not expect a flood of gold coins into the secondary market (and hence a collapse in gold coins sales) until literally past the turn of the fundamentals-driven prices toward the stage of mid-cycle "bubble" collapse.

The US Mint data on sales of gold coins suggests that we are not in the last days of the "bubble". But there are warning signs to watch into the future.

August sales by the US Mint were up a whooping 170% year on year in terms of total number of coins sold, while the weight of coins sold is up 194%. On the surface, this gives some support to the theory of gold becoming short-term overbought by retail investors (see chart below), but it also contradicts longer-term view that gold coins sales should fall around bubble peak.

Source: US Mint and author own analysis

In part, monthly comparatives reflect huge degree of volatility in US Mint sales. Looking at the longer term horizon, since January 2008, US Mint sales volumes averaged 97,011 oz with average coin sold carrying 0.82 oz of gold, the standard deviation of these sales was 45,196 oz and 0.19 oz/coin, implying that August results comfortably fit within the statistical bounds of +/- 1/2 STDEV of the mean for the crisis period. Equally importantly, August results fit within +/-1 STDEV band of the historical mean since 1986 through today. In other words, current gold coinage sales do not even represent a 1-sigma event for the entire history of gold coins sales supplied by the US Mint and are within 0.5-sigma risk weighting for the crisis period since January 2008.

Neither is the current monthly increases in demand represent a significant uptick on previous months or years demand. At 112,000 oz of gold coins sold, August 2011 is only the 19th busiest month is sales since January 2008. It ranks as the 34th month in terms of the gold content per coin sold. Again, not dramatic by any possible metrics. Since January 1988 there were 87 months in which average gold content per coin exceeded August 2011 average and on 38 occasions, volumes of gold sold in the form of coins by the US Mint exceeded last month's volume.

Again, not dramatic by any possible metrics, especially once we recognize that in terms of risk-related fundamentals, August was an impressive month with US and EU debt crises boiling up and economic growth slowdown weighing on global equities markets.

Charts below illustrate these points.
Source: US Mint and author own analysis
Source: Author own calculations based on the US Mint data
Source: Author own calculations based on the US Mint data

The data also shows that physical demand for coins is largely independent of the spot price of gold. Historically, since 1986, average 12-months rolling correlation between the spot price of gold and the volumes of gold sold in US Mint coins is negative at -0.09. Since January 2008, the average correlation is -0.2. And over the last 3 years, the trend direction of gold spot price (up) and the volumes of gold sold in coinage (down) have actually diverged (see chart). The latter is, of course, concerning and will require closer tracking in months to come. The correlation between price of gold and volumes of gold sales through US Mint coins is now negative or zero for 13 consecutive months.

Source: Author own calculations based on the US Mint data

Source: Author own calculations based on the US Mint data

The chart above also highlights the fact that the current trend levels of US Mint sales are significantly elevated on previous periods, with exception of 1986-1987 and 1998-1999 demand spikes. Since the global economic crisis began, annual coinage sales rose 7-fold from just under 200,000 oz in 2007 to 1,435,000 oz in 2009, before falling back to 1,220,500 oz in 2010. Using data through August, I expect 2011 sales to remain at around 1,275,000 oz. This implies that the 2008-2011 average annual sales of US Mint coinage gold are likely run at slightly above 2 times the average annual rate of sales of coinage gold in the period 1988-2007.

Given the state of the US and other advanced economies around the world since January 2008, this is hardly a sign of dramatic over-buying of gold by masses of retail investors. Instead, we are witnessing two core divergent trends emerging from the coins markets:

1. Since, roughly-speaking, 2009, the trend in coins sales is moving counter to the trend in spot price for gold, implying that retail investors are not rushing into gold, as one would expect were gold to be a bubble, and
2. The levels of sales of US Mint coins remain elevated, on average, since the crisis began, implying that high demand for coins, relative to historic trends, is most likely being driven by fundamentals-underpinned demand for safety.
   

In short, there is no indication, in the data reviewed, of the bubble beginning to inflate (sharp rises in gold coins demand along the trend with prices) or close to deflating (sharp pull-back in demand for gold coins).

Of course, the evidence above does not imply any definitive conclusions as to whether gold is or is not a "bubble". Instead, it points to one particular aspect of demand for gold - the behaviorally anchored, longer-term demand for gold coins as wealth preservation tool for smaller retail investors. Given the state of the US and other advanced economies around the world since January 2008, US Mint data does not appear to support the view of a dramatic over-buying of gold by the fabled speculatively crazed retail investors that some media commentators are seeing nowdays.


Disclosure: I am long physical gold and hold no long or short positions in other gold instruments.


i These and other facts about gold are summarized in my recent presentation available at http://trueeconomics.blogspot.com/2011/08/20082011-yielding-to-fear-or-managing.html.

ii As shown in the recent research paper by Profs Brian Lucey, Cetin Ciner, and myself, covering the period of 1985-2009: http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1679243