Who is buying gold?

The recent strength in gold prices has largely been driven by a combination of short covering by miners and investor demand through the use of ETFs. Central banks were likely not a major factor.

Since the beginning of this year gold ETFs have grown considerably, with holdings rising from 57 million ounces at the end of 2009 to 66m ounces at the end of August, an increase of 18% that coincided with a 15% rally in gold prices. Demand data from the World Gold Council shows that so far this year, ETFs accounted for almost 30% of the global demand for gold, exceeding demand from all but the jewellery sector.

Recently there have been reports in the press of increased buying of gold by central banks driving up prices.

While Russia, India and China have indeed increased their holdings, it appears that they did this through purchases from the IMF, meaning that the overall net effect on world gold reserves was negligible.

Additionally, purchases often show up in official reserve data as one block at a specific point in time, whereas in the case of China, for example, the purchase of 454 tonnes of gold that was announced last year in April actually took place over the six-year period from 2003 to 2009. Adjusting for the China purchase shows that while central banks have clearly stopped selling gold, they do not appear to have become net buyers.

In addition to the increase in buying by ETFs, another candidate appears to be the gold miners themselves winding up their hedge books. Traditionally, miners have been short gold through the futures market as a hedge against any fall in price from profitable levels. According to a recent industry report, it appears that the vast majority of miners have now closed their hedge positions.

Last week, the world's third largest gold miner announced that it will issue equity in order to cover its losses from being short and wind up its hedge book.

Earlier this year, the world's largest gold miner also closed its hedge book. This clearly suggests that within the industry, miners expect gold to stay at least around current levels for the foreseeable future.

In conclusion, it appears that the recent strength in gold prices has largely been driven by a combination of short covering by miners and investor demand through the use of ETFs. This is not unsurprising as gold is seen as a safe haven during times of economic uncertainty. Until the path of the global economy becomes more certain, it is likely that investment demand will continue to underpin gold.

However, this does raise the risk that when the recovery eventually takes hold, demand from investors will likely falter and unless it is replaced by growth in another sector (e.g. central banks, jewellery and industrial), gold prices could fall back to lower levels.