Gold ETF Flows Poppycock

July 08, 2011

The FT ran a story this week that tried to correlate a decline in precious metals ETF flows with the end of the bull market in gold. Let’s hope not too many investors were misled.

Because, clearly, ETF flows data in the wrong hands can produce misguided conclusions like these. By the way, I’m not the only one who noticed, as Adrian Ash of pointed out the same thing.

In any case, to say that a decline of 0.7 percent in the volume of gold held by physically backed ETFs in six months is the canary in the coal mine of the bull market in gold reveals misunderstanding of both the ETF industry and the gold market.

Not only have ETF flows not been correlated to changes in the price of gold over any meaningful timeframe, but the impact of the western hemisphere on the gold market is grossly overstated.

Gold ETF Holdings Peaked Last Summer

A decline in the holdings of physically backed gold ETFs would be a stronger indication of an abatement of the bull market in gold were it not for the fact that these holdings have been on the decline since last summer. According to The VM Group, ABN AMRO’s natural resources research unit, ETF holdings of physical gold peaked at just under 3,000 metric tonnes last June.

And what has the price of gold done in the year since then?


Gold rose 24.6 percent since ETF holdings peaked in summer 2010. In fact, gold also climbed to new all-time highs against all of the currencies constituting the US Dollar index, save for the Swiss franc.

Furthermore, a decline in gold futures positions at the COMEX futures exchange tells us little about the long-term trend of the gold market. A “significant shift” in net long positions in three-month gold futures may affect prices at the margin in the short term, but tells us little about real investment demand.

Conversely, the World Gold Council’s Q1 Gold Demand Trends, does. These data show that demand for gold bars actually set an all-time high in the first quarter while investment demand globally increased over 11 percent year over year. In fact, in its report, the Gold Council says: “Much of the 11 percent year-on year increase in tonnage demand was the result of strong growth in investment demand.”

If the Western investment community has really reached a point of “demand saturation,” from where is this investment demand coming?

East Vs. West? East Wins

The FT article’s biggest mistake may be in attributing -- even if indirectly -- the “decade long rally in gold” to western investment appetite. Even a casual glance at the World Gold Council’s Gold Demand Trends Report will refute this idea. China and India accounted for 57 percent of global physical gold demand in the first quarter, with China’s demand growing 32 percent even in the face of a 25 percent increase in local currency prices.

China and India have become the top two physical gold markets globally, and without a significant expansion of physically backed ETF investment in these markets. China doesn’t have gold ETFs, so investors, for now, usually choose to buy physical gold or contracts traded on the Shanghai Gold Exchange and the Shanghai Futures Exchange.

This is about to change. Today an article in Bloomberg reveals that the implementation of a new law in China allowing for the purchase of overseas financial assets has begun to bear fruit.

Chinese asset managers who have raised nearly $70 billion are about to deploy as much as 20 percent of these funds to gold ETFs, according to Bloomberg News. This new outlet for gold investment demand provides more choice in China, which is the world’s largest gold market.

What Will Drive Prices In The Future?

None of this is to say that Gold prices will rise indefinitely or that prices can’t come down.

However, it’s clear that ETF flows have little if any bearing on the price of the metal. It’s therefore unlikely that the new regulations in China allowing for the purchase of foreign financial assets will drive prices higher, even if all $70 billion of the recently raised assets find their way into gold ETFs, such as the oldest and biggest of them all, the SPDR Gold Shares (NYSEArca: GLD).

Of course, these short-term dynamics regarding ETF flows and futures positions make for interesting headlines. Unfortunately, they tell us little about the fundamentals shaping the long-term gold market.

What does give us the most information about the long-term prognosis for gold is the level of real interest rates globally. As long as they remain negative, gold will continue to be viewed as a store of wealth.

Stated plainly, gold will continue to react to real macroeconomic factors even as some people continue to look for simple explanations to explain the long-term trend.

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