DEZ
COT Gold Report - Gold ETFs Changing Market Dynamics
By Gene Arensberg
18 Feb 2006 at 06:35 PM EST
HOUSTON (ResourceInvestor.com) -- An expected pullback for gold got underway about two weeks ago and after a $40 retrace the metal has bounced off the technically popular 50-day moving average.
Whether that’s it for this pullback remains to be seen, but meanwhile there is little doubt that the dynamics for the gold market are changing, and changing in a profound way.
We lead off with some commentary on Gold ETFs this week.
Gold ETFs Already Gaining Broad Acceptance
For a little over two decades beginning in the 1980’s the price, and more importantly the direction of the price of gold, was and to a large extent still is, determined by the gold futures markets. More and more during that period a growing number of analysts and market watchers came to believe that the normal checks and balances to a conventional free market were being corrupted, or rather controlled by those paper gold markets.
The difficulty and expense of owning physical gold along with the relatively complicated nature and elevated requirements of trading futures limited the playing field and thus the potential number of investors for the yellow metal.
Isn’t it ironic that in the United States such impediments would have existed for people to own the only real money on earth?
For years the World Gold Council dreamed of making gold more accessible to mainstream investors. Mainstream investors, including small, large and institutional varieties longed for the same thing. For years efforts to come up with a viable, easily tradable pure-gold-metal fund languished as industry resistance, tax laws and regulatory hurdles seemed insurmountable. Not any more.
Make no mistake about it, just a couple years since their inception, the new exchange traded funds (ETFs) for gold are fast changing the dynamics of the gold market.
ETFs are altering and challenging the once unquestioned dominance of the relatively small market for physical gold bullion by a comparative handful of very large players, bullion banks and futures, or paper gold markets.
The good word is getting out.
Reuters reported on Monday that ETFs sponsored by the World Gold Council (WGC) had accumulated 429 tonnes of gold in about two years.
The flagship gold ETF is the streetTRACKS Gold Trust which trades on the New York Stock Exchange under the symbol GLD, and it has accumulated 342.99 tonnes of that 429 tonne total for investors in the trust.
As of February 17, GLD alone had a net asset value of just under U.S. $6.1 billion after having been in existence for barely 15 months.
According to the WGC, 429 tonnes* would rank 12th globally in largest gold holdings including countries and central banks. Those figures do not include the Barclays gold ETF which is not under the WGC umbrella.
Barclay’s iShares COMEX Gold Trust [AMEX:IAU] has sopped up an additional 32 tonnes. That is the same Barclay’s that is seeking approval for the new silver ETF.
Gold ETFs are not just ordinary tracking stocks and they are classed as a continuous offering. Their share structures and inventories of the commodity rise and fall according to investor demand.
For example, streetTRACKS Gold Shares adds or sells gold and issues or buys back the number of shares in play so that each GLD share tracks very closely to the London PM Fix price of 1/10 of an ounce of gold.
This is in response to even small imbalances in the share price of the fund versus the actual metal price. The books are squared daily and changes to the fund’s NAV and metal holdings are published on their website, also daily.
ETFs allow gold investment by many more large investors now who would not invest in actual physical gold otherwise.
Before the ETFs, to invest in gold – especially in quantity - was more complicated and much more expensive. One either had to take physical possession of the metal or arrange for secure storage of it for a fee.
Insurance, delivery, and safety are all factors which are daunting to non-gold bugs, not to mention an expensive drag on the investment. So the field for larger investors for gold metal was always limited.
For smaller investors who might swing by the local bullion dealer on the way home to buy a few U.S. Gold Eagles once a month, for example, the difference in opportunity today is quite remarkable. The 2% to 6% both-way premiums legitimately charged by middlemen and bullion brokers for gold bullion coins, ingots and bars means that the investor has to be able to cover a 4% to 12% spread just to break even on a physical gold investment.
At the extremes that is the equivalent of having to pay $53 for a $50 stock the day bought and receiving $47 for the same $50 stock if selling. Most traditional equity investors wouldn’t accept that kind of spread for stocks, but it is the norm for small bullion investors.
There is certainly nothing wrong with the bullion dealer charging a reasonable fee. Bullion dealers have to pay overhead like any business and they work on the thinnest of margins possible. Until recently there was no practical alternative for the small investor to paying gold premiums.
Today, however, the small investor has an easily executed choice provided they don’t mind not taking actual possession of the metal.
With any online brokerage account the small investor can add shares of one of the large gold ETFs and do so literally at the prevailing spot price or very close to it for just the cost of an online brokerage commission. With GLD for example, each 10 shares represents one troy ounce of .9999 pure gold the trust keeps parked in ultra-secure London vaults. Want to add gold exposure to an investment portfolio? No problem. It takes just a few clicks right from the comfort of the study or office computer terminal.
Thanks to the new gold ETFs the small investor actually has the very same purchasing power premium-wise as the largest traders on earth. Whereas before there was a small, but dedicated number of gold investors willing to put up with the difficulties and up-front expense to invest, there are legions of experienced online and traditional equity investors that will undoubtedly add gold to their investment portfolio now that they can do so without the hassle and expense involved with actually taking possession of the metal. That’s powerful stuff and it is one reason that the gold market dynamics are in the beginning stages of working out a new order.
Imagine the explosive future possibilities when gold registers higher on the now open-ended “gold popularity Richter scale” with so many more investors able to participate. It is exhilarating to consider that an entirely new source of liquidity has opened up and even though still quite new, is already gaining broad acceptance in the marketplace.
Ironically the most vocal of opposition to the gold ETFs came not from the obvious antagonists to higher gold prices, the jewelry manufacturers and the paper-gold players, but instead spirited opposition came from the gold bug camp itself.
People for whom gold is more of a religion to be kept “pure” than just an investment or trading vehicle.
God bless the gold bugs, because they occupy an important niche in the gold market. One tenant of their gold code revolves around the notion that gold is to be kept nearby so as to be handy in times of catastrophic economic stress or sudden changes in government policy toward gold ownership, and more power to them.
During the depths of the two-decade gold bear market the gold bug champions dug in to put pressure on and expose the anti-gold carry trade that had developed in the 1990’s – an issue so much has been written about. However, if the gold market had to rely only on the old order, (of speculative paper gold markets versus the producers and manufacturers plus the relatively small subset of investors that actually would own the physical metal) the market would probably still be more constrained by the actions of the biggest players of the old order.
Today most of that gold bug opposition has faded as massive amounts (for such a short time) of gold metal has already moved from the prevue of the few large bullion masters into the virtual hands of investors large and small worldwide. And, it sure looks like this is just the beginning.
The vocal opposition has evaporated as even the staunchest of the gold bugs must now sense that new gold demand from the ETFs contributed in a big way to the recent quarter-century highs and an increase to the value of their hoards of gold coins, bars and medals.
While it is still much too soon to measure, and while the old order still wields considerable influence in the market, there is little doubt that the market pressure provided by the ETFs has at least modified the old command and control and through the actions of perhaps tens of thousands of large and small investors, the WGC’s now realized dream of mainstream gold accessibility has provided a much needed addition to the checks and balances of a global free market.
*(A metric tonne of gold contains 32,150.75 troy ounces. At $550 gold each tonne is worth about $17.7 million. 429 tonnes are worth about $7.6 billion.)
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