Whales in the gold market

Last April gold investment analysts where excited to see a new institutional player enter the gold market. The University of Texas Investment Management Co. took delivery of nearly $1bn of gold bullion into a New York vault. The reason gold analysts were so interested was because large institutional players had been largely absent from their market and their huge purchasing power had therefore not had its potentially significant positive effect on the gold price.

The gold purchase by America’s second largest academic endowment was noted in case it was the start of a trend. Nonetheless, continued institutional bids into the gold market did not follow in great enough numbers to identify a compelling trend. Apart from last summer’s run to over $1,900/ounce, the gold price has not hinted at notably increased institutional buying of gold. Gold investors were left waiting and wanting.

However, the Financial Times reported some interesting news for those monitoring such a trend yesterday.

Okayama Metal & Machinery has become the first Japanese pension fund to make public purchases of gold, in a sign of dwindling faith in paper currencies. Initially, the fund aims to keep about 1.5 per cent of its total assets of Y40bn ($500m) in bullion-backed exchange traded funds, according to chief investment officer (CIO) Yoshisuke Kiguchi, who said he was diversifying into gold to “escape sovereign risk”.

Pension funds and gold bullion

Traditionally pension funds have ignored gold due to their focus on yields. Japan is the world’s second largest pension market, and this move by Okayama Metal & Machinery is worth paying close attention to. Such a move into non-yielding assets becomes more palatable in a world of negative real interest rates where institutional investors are paying for the ‘privilege’ of holding government paper.

The fund’s aforementioned CIO appears to have talked his investment committee into a long term wider view of asset allocation. Mr Kiguchi had made the case that a lack of yield needed to be balanced against currency and default risk. Loose monetary policies and the durability of fiat currencies seemed to be on his mind when he commented: “from a very long-term point of view, gold may be one of the safe currencies”.

This point about long term asset allocation is one that has been articulately made previously by Ben Davies of Hinde Capital. Mr Davies and Hinde Capital have also been observers of Japan’s potential in the gold market, and according to the FT, this potential may be morphing from latent demand into patent demand.

Mizuho Trust & Banking, a unit of Mizuho Financial Group, has begun to offer investment schemes allowing smaller pension funds to invest in gold… While few fund managers are counting on a crash in core assets such as Japanese government bonds, said Takahiro Morita, head of the Tokyo arm of the World Gold Council, a producers’ association, they were increasingly receptive to the idea that gold could act as a buffer against shocks. “Last year’s tsunami and the eurozone debt crisis shows that it was wise to expect the unexpected,” he said.

Nomura, Japan’s biggest wealth manager, added a gold option to its monthly survey of 1,000 randomly selected retail investors in February. Every month since, gold has been ranked the third-most desirable addition to portfolios, well ahead of competing assets such as investment trusts, bonds or foreign securities.

Succinctly explaining recent performance across asset classes, Yoshio Kuno, Japan head of Newedge, the futures broker, argued that “If you look at assets over the past couple of decades, equity has been a loser, while fixed income offers tiny coupons. Gold is becoming an acceptable currency substitute.”

This news and sentiment out of Japan suggests further evidence of declining trust in fiat currencies to us, but is a wider trend of growing institutional demand for gold appearing?

Whales and the gold market

Recent SEC filings, reported by ZeroHedge, show other institutions participating in the gold market. Most of these names are familiar to gold market observers but some of them appear to be increasing their participation whilst others are new buyers.

Eton Park Capital, Paulson and Co., PIMCO, Soros Fund Management, and the Teacher Retirement System of Texas all bought shares of the world’s largest gold exchange traded fund (ETF), known by its ticker of GLD, in the first quarter of 2012.

Within this Soros quadrupled his gold investment position compared to the previous quarter, PIMCO and the Teacher Retirement System of Texas were also net buyers, whilst Eric Mindich’s Eton Park Capital was a new buyer with a purchase of 739,117 shares, having held no position in GLD at the end of 2011.

Large buyers need liquid gold products

It is also worth noting the size of some of this participation. Investment by Okayama Metal & Machinery of $500m and Eton Park Capital of $110m is larger enough for these buyers to need a highly liquid gold investment solution.

Institutions that need to invest in regulated securities tend to look towards the largest ETFs, like GLD, as only these products are liquid enough to handle their buying and selling without inordinately affecting the price. This can be especially relevant for some pension funds that may be unable to take delivery of physical bullion as the University of Texas Investment Management Co. and David Einhorn’s hedge fund, Greenlight Capital, did.

Eric Sprott’s Physical Gold Trust and the Central Fund of Canada might be a structurally superior means of achieving gold, or precious metals ownership, but at the time of writing the Sprott Trust’s Net Asset Value (NAV) was less than $2.2bn and the Central Fund’s NAV was less than $4.8bn. This is compared to GLD’s current NAV of $63.5bn. Whales sized gold buyers need deeper liquidity and, regardless about opinions as to its suitability for gold investment, GLD has it.

Whilst the above institutional action in the gold market might not point to a firm trend of hot institutional activity it is worth paying attention to. Trends have to start somewhere, and whilst gold is not significantly held by institutions generally, the motivating concerns mentioned by Okayama Metal & Machinery’s CIO might be held more widely across the industry.

The move into gold by Okayama Metal & Machinery should be looked at in the same light as the University of Texas Investment Management Co.’s gold investment last year. For now we just hear a slow dripping sound as financial glaciers melt and capital begins to look for more secure homes and better collateral.