History Not On Side Of 2016’s ETF ‘Gold Rush’

The stampede into physically backed gold funds should raise eyebrows.

DrewVoros_200x200.png
|
Editor-in-Chief
|
Reviewed by: Drew Voros
,
Edited by: Drew Voros

Working in San Francisco off of Sutter Street, I’m frequently reminded of John Sutter, “credited” with discovering gold in 1848 at the sawmill he was building along the American River near what today is Sacramento.

That, as we all know, triggered the great California gold rush. But what many may not know is that the gold rush ended badly for Sutter, as well as for hundreds of thousands of others.

The term “gold rush” sounds exciting and potentially lucrative, and in the “1849 gold rush,” that was certainly true for some, but not for the very large majority of the 300,000 gold prospectors who came to California. Rather, it was the people who sold products, supplies and services to the swarm of “forty-niners” intent on finding their pot of gold who made the lion’s share of wealth.

Even for Sutter, whose construction crew supervisor John Marshall actually “discovered” the specs of gold floating in the mill’s water channel, the gold rush ended badly. He was more intent on finishing his mill than exploiting the riches at his feet. Blind to what was in front of him, Sutter compounded that mistake by allowing his workers to prospect for gold on their time off.

Soon his land and newly built sawmill were overrun with prospectors when word got out after his workers went to San Francisco to cash in. Any gold he might’ve found did not make up for his loss of land, and his business that never got off the ground.

Sutter eventually died penniless despite the riches that once floated at his feet. Marshall also met financial demise when he invested in a failed gold mine after the gold rush. He also died in poverty.

Sutter’s and Marshall’s fate were like nearly all the prospectors who risked everything only to come up dirt poor.

The First 21st-Century Gold Rush

Fast-forward 149 years, and a new gold rush was about to explode, but instead of picks and axes, gold prospecting in the 21st-century would be about clicks and asks/bids.

On Nov. 12, 2004, the first globally available gold rush began, meaning it wasn’t isolated to one geographical area like California. On that date, the SPDR Gold Trust (GLD | A-100) launched, which introduced many more of the global investing masses to this a new type of investment vehicle, the exchange-traded fund, and to a new way to access gold.

In less than a week, the physically gold-backed GLD attracted $1 billion, making it to this day the most successful ETF launch. But this was nothing compared with what was about to come. Seven years later, this gold rush peaked, as GLD became the largest ETF in the world, even outranking the SPDR S&P 500 ETF (SPY | A-97), with $76 billion in assets and record share price as spot gold hit $1,900. But fate, or maybe the specter of the California gold-rush bust, came a-haunting.

Shortly after that date, the seven-year-old gold rush began its transformation into a gold bust. California’s gold rush lasted seven years as well: 1848-1855.

Soon after gold prices hit their peak, a long slide down the mountain began, with GLD losing more than $55 billion in assets along the way, to a new recent low price on Dec. 17, 2015, of $100.8, as spot gold closed at $1,051/oz.

 

The 2016 Gold Rush Or Gold Crush?

What’s interesting about the chart above is how GLD’s gold holdings (a proxy for inflows) and the share price of GLD (a proxy for spot gold) walk hand in hand. You could argue that the buying of gold ETFs had a major impact on boosting gold, just as the selling of gold ETFs after the 2011 peak helped push the yellow metal to its recent depth last December.

Clearly, the Fed’s three quantitative easing programs made gold appealing as Treasury yields retreated during the run-up, but the influence of GLD and other physically backed gold ETFs also were clearly a new fundamental.

 

But a funny thing happened on the way to gold’s funeral last December, as the Federal Reserve raised interest rates for the first time since before the global financial crisis, which was supposed to make gold even less appealing.

As 2016 kicked off, the gold worm began to turn. The global economy was stalling, and then in February, another “flash crash” struck financial markets—similar to the one in August 2015—and spooked the investing world into safe-haven investments like gold.

The “2016 gold ETF rush” was on.

Eureka!

Since the beginning of the year, the four U.S.-listed physically backed gold ETFs have seen the following inflows—GLD: $11.5 billion; iShares Gold Trust (IAU | B-100): $1.9 billion; ETFS Physical Swiss Gold Shares (SGOL | B-100): $113 million; VanEck Merk Gold (OUNZ | A-100): $53 million.

That’s more than $13.5 billion in less than six months that went to purchasing 11.1 million ounces of gold, using 2016’s average gold price of $1,217. Eureka!

After the first six months of the year, all four funds are up nearly 25%. They all track the gold’s spot price, less expenses and liabilities, using gold bars held in vaults around the world. For GLD, the gold is held in London, and for SGOL, in Zurich.

Now keep in mind the chart above showing GLD flows and share price, and consider this one-month chart comparing GLD and SPY:

Chart courtesy of StockCharts.com

 

The year so far has been good for gold in both price appreciation and demand, but only last week’s surprising ‘Brexit’ victory has boosted gold lately. Before the election, gold was heading down the hill again, even during the run-up to the neck-and-neck “Brexit” vote. In the wake of more than $2 trillion in global equity losses Friday, it’s not surprising there was a stampede to gold, with assets driven more by psychological sentiment than fundamentals.

So far this month, with gold trading at its high for the year, investors continue to swarm “Sutter’s mill,” if you will, with more than $2.6 billion in new assets flowing into GLD. The fact that gold is up nearly 25% has deterred no one.

End Of The Multiyear Gold Rushes

We have seen the last of the seven-year gold rushes. In fact, it could be that the “2016 gold rush” may not even last seven months, much less to the end of the year. While the impact of ‘Brexit’ may seem obvious in Europe, it will not have similar reverberations here, and even less so Asia, where stocks rose on Monday. Asia and India are the largest purchasers of gold.

If you have realized double-digit gains this year in gold, it might behoove you to sell now and take money off the table. If you bought at recent highs, then you may need to buckle up, for every passing day. the shock of ‘Brexit’ will fade and the realization that the United Kingdom won’t leave the European Union any earlier than 2019 will settle in. Gold was down this morning after a two-day, post-Brexit rally.

The only thing that will change going forward will be investor sentiment to gold, which will cool, as it always does, after a geopolitical event gives it a quick boost.

“The gold story over time will peter out, because there's nothing real to it,” said Mark Dow, founder of Dow Global Advisors, who has 20 years’ experience as a policymaker, investor and trader focused on global macro and emerging markets. “A lot of it is psychological. Gold got oversold quite a bit.”

As we saw at the beginning of the year, the reversion to the mean for gold kicked in after an extended decline. Conversely, a reversion to the mean after a near 25% appreciation could easily kick in, and at a much more rapid pace.

As Sutter and Marshall painfully experienced, gold rushes can end badly, so take heed.

Drew Voros can be reached at [email protected].

 

Drew Voros has nearly 30 years' experience in financial journalism. He was a longtime business editor for the Oakland Tribune and sister papers of the Bay Area News Group, and finance writer for the Hollywood trade publication Variety. Voros' past roles have also included editor-in-chief at etf.com and ETF Report.