Key takeaways 

 

•         Investors remain key gold price drivers; epicentre has shifted from futures to physically backed ETFs.

•         Retail investors are critical. Given extremely high inflows, there were some dislocations earlier this year.

•         EFPs also spiked, but quotes have subsided. Return of the popular short EFP trade.

 

 

Investors remain the gold price drivers

 

The recent gold price rally has been driven by investors, who have steadily increased their exposure to the yellow metal, a dynamic that is, as such, not unusual. Digging a bit deeper, positioning through futures was historically the marginal price driver. Yet, physically backed ETFs have increasingly become the vehicle of choice to access the gold market. Indeed, squaring off futures with physically backed ETFs, recent flow data suggests that paper gold is no longer as important as it used to be.

 

ETFs are the dominant vehicle to access the gold market

 

To put assets under management at physically backed ETFs into context, these vehicles now hold the equivalent of 40% of gold stored in LBMA vaults. Given that most of the ETF holdings are sticky, this has removed some liquidity from the gold market. Looking into market participants, investment advisors, which typically represent retail investors, remain by far the single biggest holders of exchange traded funds at 71%. As such, while institutional investors, who in the past often traded futures, have a share in combined futures and ETF open interest, retail investors, typically through physically backed ETFs, are now more critical. Linked to that, significant inflows into exchange-traded funds showed up in periodic dislocations between ETF prices and NAVs over the summer, although these have by now normalised.

 

EFP quotes are normalising

 

Dislocations also showed up in exchange-for-physicals (EFP), which are, essentially, a market-neutral position in a CME futures contract and OTC physical gold. During the lockdowns, logistical challenges and concerns over liquidity on CME meant that EFPs spiked. Since then, steady gold deliveries into the exchange's warehouses mean that trading on CME has started to normalise; incidentally, these shipments along with extremely high inflows into ETFs at some stage raised concerns over the health of the physical gold market. Putting it all together, with dislocations now having subsided, and there is scope for the popular short EFP trade to make a return.