Gold Investment Resuming
Gold Investment Resuming by Adam Hamilton – Zeal, LLC
Gold has surged dramatically to major breakouts since its usual summer-doldrums lows. That’s naturally rekindled interest in this leading alternative investment, despite the record-high stock markets. Investors are starting to return to gold again to prudently diversify their stock-heavy portfolios. That’s very bullish for gold, as investment capital inflows can persist for months or even years. This shift is most evident in GLD.
The American SPDR Gold Shares is the world’s leading and dominant gold exchange-traded fund. Since its birth way back in November 2004, it has acted as a conduit for the vast pools of stock-market capital to migrate into and out of physical gold bullion. The marginal gold investment demand, and sometimes supply, via GLD can be big and varies wildly. Thus GLD-share trading is often gold’s primary short-term driver.
The definitive arbiter of global gold supply and demand is the venerable World Gold Council. It publishes highly-anticipated quarterly reports called Gold Demand Trends. They offer the best reads available on global gold fundamentals. At first glance, it’s not apparent why gold-ETF demand plays such a massive role in driving gold’s price action. But digging a little deeper makes this crucial-to-understand relationship clearer.
According to the WGC, over the past 5 years from 2012 to 2016 jewelry demand averaged about 54% of overall global gold demand. Total investment demand including physical bars and coins in addition to gold ETFs averaged just 26%. Breaking that category down further into bars and coins separate from ETFs, they weighed in at averages of 28% and -2% of world gold demand respectively over the past 5 years.
The key to ETFs’ outsized impact on gold prices is in the extreme variability of their demand. Across that same span, total gold demand only varied 10% from the midpoint of its worst year to best year. For jewelry that variance ran 27%, as gold’s largest demand category is relatively inelastic to gold’s price. Variability for bar-and-coin investment was higher at 49%. But that’s still nothing compared to ETFs’ wild swings.
Global gold-ETF demand between 2012 to 2016 varied radically from a low of -914.3 metric tons in 2013 to a high of +534.2t in 2016! The percentages don’t work with a negative number, but that 5-year variance of 1448.6t is vast beyond belief. Despite global gold-ETF demand averaging just -2% of total world gold demand over that span compared to 54% for jewelry, in raw-tonnage terms ETFs’ variability ran 2.2x jewelry’s!
Gold prices are set at the margin, and capital inflows and outflows via gold ETFs dwarf changes in every other gold demand category. The extreme volatility in gold investment demand through ETFs from stock traders overpowers everything else. When stock investors are buying gold-ETF shares faster than gold itself is being bought, gold rallies. That investment buying fuels major uplegs and entire bull markets in gold.
The mission of gold ETFs including GLD is to mirror the gold price. But the supply and demand of ETF shares is independent from gold’s own. So when stock investors buy gold-ETF shares faster than gold is being bid higher, those share prices threaten to decouple to the upside. Gold-ETF managers only have one way to prevent this tracking failure. They issue new gold-ETF shares to offset that excess demand.
Selling new gold-ETF shares to stock investors raises capital, which is then plowed into physical gold bullion held in trust for shareholders that very day. This process effectively shunts excess demand for gold-ETF shares into the underlying gold market, bidding gold higher. Gold ETFs including GLD could not track the gold price if this mechanism for equalizing differential capital flows between them didn’t exist.
The opposite happens when gold-ETF shares are sold faster than gold itself is being sold. That forces the shares to disconnect from gold to the downside. Gold ETF managers avert that failure by stepping in to buy back those excess shares offered. They raise the capital necessary to sop up this excess supply by selling some of the gold bullion underlying their ETF. Gold ETFs are a capital conduit between stocks and gold!
Because of the massive size of the US stock markets, GLD capital flows are more important to gold than all of the other gold ETFs around the world combined. GLD’s managers are very transparent, publishing its physical-gold-bullion holdings daily. That offers a far-higher-resolution read on what’s going on in gold investment than the WGC’s quarterly fundamental reports. GLD’s holdings are the key to gold’s fortunes.
When GLD’s holdings are rising, that means American stock-market capital is flowing into the global gold market. When GLD’s holdings are falling, investors are pulling capital back out of gold. There is nothing more important for gold’s overall price trends than these GLD capital flows. From extremes gold-futures speculators can overpower GLD’s influence on gold from time to time, but these eclipsing bouts don’t last long.
I’ve actively studied GLD’s dominating influence on gold prices for many years now. The hard data on this is crystal-clear, as we’ll discuss shortly. But unfortunately many if not most speculators and investors in gold, silver, and their miners’ stocks still don’t understand this. You can’t really grasp what’s going on in gold, and therefore the entire precious-metals complex, if you don’t closely follow GLD’s holdings daily.
This week’s chart looks at GLD’s physical gold bullion held in trust for its shareholders superimposed over the gold price since 2015. When American stock-market capital is flowing into gold via differential GLD-share buying, gold rallies. When that capital heads back out, gold falls. These gold-investment trends often take many months to play out, and a major new GLD-share buying spree is just getting underway.