Gold ETFs Main Driver Of Price Surge

By now, most everyone is well-aware of the enormous sums of money that have flowed into gold ETFs this year. The SPDR Gold Trust (GLD | A-100) is leading all ETFs with year-to-date inflows as of May 11 of $7.7 billion, according to FactSet data.

Combine that with the $1.7 billion that's gone into the iShares Gold Trust (IAU | B-100), and we're talking about a whopping $9.4 billion worth of inflows into these two ETFs in just a little over five months (for comparison purposes, the two funds had combined outflows of $2.4 billion in 2015 and outflows of $3.5 billion in 2014).

In fact, the buying in gold ETFs this year has been so large that the World Gold Council reported yesterday that global gold demand grew at its fastest pace ever in the first quarter―21% year-over-year. The buying in these funds was so big that it offset significant declines in demand from the two largest gold-consuming markets: China and India.

According to the WGC, consumer demand in India dropped 39% year-over-year in the first quarter, while demand in China dropped 12%.

Q1 Gold Demand

Source: World Gold Council

In other words, the buying of gold ETFs was single-handedly responsible for this year's gold rally.

Just who is buying, and what in the world is going on to cause so many investors to rush into gold all of a sudden?

Broad Investor Base

The World Gold Council, sponsor of the largest gold ETF, GLD, believes there are many types of investors buying gold ETFs this year. Inflows into these funds have come "from a broad investor base, from institutional to private," according to the council's Demand Trends report.

Institutions have been the "driving force," but retail investors are also a "considerable contributor" to the buying. The WGC added that most of the investment demand is coming from Western investors, though the nascent Chinese gold ETF market saw a doubling in its assets as well.

Three Reasons For Buying

Just as the investor base for gold is quite diverse, so too are the reasons for buying the yellow metal.

Some of the buying in gold ETFs could be related to performance-chasing. Up more than 20% so far this year, the yellow metal is one of the top-performing assets of 2016.

YTD Gold Price

That said, performance-chasing likely isn't the only―or even the most important―reason for gold's newfound popularity among ETF investors.

The WGC cites three reasons in particular for the buying. The first is the negative-interest-rate policies implemented by central banks in Japan in Europe. These policies "significantly reduced the appeal of sovereign bonds as stable, low-risk assets," said the council.

The second factor is China's devaluation of the yuan, "which fueled fears over the country's economic health and the potential impact on global growth."

The third factor is U.S. interest-rate policy. Rates are expected to rise much more slowly than previously anticipated in light of the weak economic growth in the country.

Other Factors

Of course, there are a few other concerns we could add to the WGC's list. One is the fact that the stock market is struggling.

The S&P 500 hasn't hit a new high in almost a year; there has been two 10%-plus corrections in the market during the past eight months; and corporate earnings have declined for four-straight quarters.

Under these conditions, a little bit of gold in the portfolio could act as a good hedge against stock market volatility.

Meanwhile, some investors are worried that the economic expansion may be getting long in the tooth; it has been nearly seven years since the last recession ended. That makes this expansion the third-longest on record (the longest was the 10-year period between March 1991 to March 2001).

These investors reason that it's only a matter of time before the next recession hits, and they're hedging their bets with gold.

No Guarantee Of Gains

Clearly, there are plenty of good reasons for investors to be betting on gold. The nearly $10 billion that's come into GLD and IAU this year reflects a host of concerns investors have about economies and the financial markets, but it's no guarantee of future gains in the gold price.

After all, outside the investment segment, demand is lackluster. For the rally to continue, investor demand must continue unabated. That could happen, especially if volatility strikes financial markets again or a recession hits, but it's not a sure thing by any means.

Contact Sumit Roy at [email protected].