Gold ETFs are singlehandedly moving gold prices up, recent industry reports suggest. This may be the first example of an ETF moving its underlying market. It confirms how much investors value the convenience of owning gold without taking physical position or buying options. It is also potentially cause for caution, since investors are dominating the market for the first time in many years.
StreetTRACKS Gold Shares (NYSE:GLD) has accumulated over $7.3 Billion in bullion, while iShares Comes Gold Trust (AMEX:IAU) has accumulated nearly $900 Million. In both cases, the funds purchased actual bullion and did not borrow the underlying asset as is so often done with stock ETFs. Astonishing amounts of the shiny metal are being locked up in vaults in London to back this paper.
No other ETF is thought to have moved its market before. Where is the evidence that this might be true here? All other categories of gold usage (jewelry, industrial, gold coins, etc.)in tonnage are down or lackluster. Only ETFs are growing volume use, and without their presence it seems inconceivable that prices could have risen so sharply. Total tonnage demand is actually falling. It should be noted that because of price increases, in dollar terms all demand categories rose, and total demand rose 9% in dollars during the past year. Demand figures in tonnage from 1st Quarter 2006 vs. 1st Quarter 2006 are:
|Tons||Q1 2005||Q1 2006||% change|
Source: World Gold Council; (not all demand categories listed)
Tonnage demand for jewelry, the traditional mainstay of the metal and still the dominant use of gold, plunged in the face of price hikes. Critical Indian jewelry demand in tonnage was hit hard, according to the latest survey by GFMS, a gold industry research group in London. This indication of fairly elastic demand does not bode well for bulls. Jewelry buyers appear to have a limited budget and will simply buy less of the metal as it goes up. (As noted, jewelry buyers are still spending more in dollar terms).
In a resounding victory for ETFs as a vehicle, investors are fleeing physical bullion at precipitous rates even as they rush into gold ETFs. The convenience of buying gold from a stockbroker and not a specialty trader is winning out over the emotional comfort of owning physical metal. Investors apparently are not afraid of a meltdown of civil society as much as inflation. It seems clear that the ETFs have satisfied a pent-up demand for easier access to gold as an investment.
Declining supply is clearly squeezing the market. Key components of supply are hedging activity of producers and sales by central banks. During the last year producers unwound or "de-hedged" their positions and central banks slowed their selling, which in both cases lowered available supply. These trends cannot persist forever. Also, new investment in production is going on now as a result of persistent high prices, and there are generally many months or even years of time lag between mining investment and delivery of metal. Some easing of price pressure from new production can be expected for at least several years.
At the moment there is no question that investors and in particular ETF investors are driving the market, and that should be cause for some caution. The more gold is snapped up by speculators, the more volatile it is likely to be. Investor profiles appear mixed. Both investors coming in for the first time and intending to stay long-term and short-term speculators are buying the ETFs. Regardless of the proportion of each, investors hoping to resell their gold at a profit increasingly will have to sell to other investors, not retail buyers who are balking. At some price point the only trading theory that supports this course of action is the dubious "Greater Fool Theory". Demand and supply numbers are providing insight into what is really happening with gold, and two ETFs for the first time are moving their underlying market.