Gold ETFs Help Boost Gold Prices

More than $5 billion has come into physically backed gold ETFs this year, pushing the yellow metal higher.

One of the top-performing assets so far in 2016, gold has been attracting attention. Jittery investors―fearing that the oil and emerging-markets-led downturn in markets this year may continue―have plowed billions of dollars into physically backed gold exchange-traded funds.

The sudden exuberance for gold began right at the start of the year and continues till this day. The two largest gold ETFs, the SPDR Gold Trust (GLD | A-100) and the iShares Gold Trust (IAU | B-100), saw combined inflows of $5.1 billion just in the first several weeks of the year.

Of course, it remains to be seen whether this strong appetite for gold ETFs continues. But if volatility remains a feature of the financial markets this year, it stands to reason that investors―who have already shown a willingness to aggressively buy gold ETFs―will go on doing so.

If that's the case, gold prices are likely to get a lift.

ETF Demand Fuels Physical Demand

For most ETFs, fund flows are merely an indication of where certain investors are doing their buying and selling. Particularly for stock and bond funds, buying in an ETF has little to no impact on the underlying securities.

But for gold, it's a different story. ETF flows can have a pronounced impact on underlying gold prices, and in fact, may be partly responsible for this year's gold advance.

Over the past decade, the correlation between gold prices and the amount of gold held by gold ETFs has been relatively strong.

Spot Gold & Gold ETF Holdings

Naturally, that raises the chicken or the egg question: Are moves in gold prices influencing investors' trading activity in the gold ETFs, or is trading activity in gold ETFs driving the gold price?

There's probably a little of both happening. But it's undeniable that inflows and outflows from gold ETFs can affect the metal's price by significantly altering the physical supply and demand balance of the market.

That's particularly the case when a whole bunch of money flows into the ETFs in a short period of time―as has been the case this year.

The amount of gold held by ETFs began the year at 47 million troy ounces; today, they hold a combined 53.6 million ounces. That gain of 6.6 million ounces—about 205 metric tons—is equal to nearly a fifth of the total global demand for gold from all sources in the fourth quarter of last year.

Gold ETF Holdings

It's no surprise that a spike in demand of that size may be playing a part in driving gold prices higher.

Of course, it goes both ways. In 2013, the 880 metric ton decrease in ETF gold holdings played a major role in the metal's 28% price decline that year.

Nevertheless, bulls can take solace in the fact that investor appetite for gold ETFs seems to be perking up after three-straight years of steady selling.

Contact Sumit Roy at [email protected].