Adam Hamilton, CPA: The flagship SPDR Gold Trust ETF (NYSEARCA:GLD) has suffered a radically unprecedented mass exodus this year. The capital fleeing this single vehicle was the primary reason gold plunged so dramatically in 2013’s first half. But just this week, money started flowing back into GLD for the first time in months. This likely marks the dawn of the GLD exodus’s reversal, which is wildly bullish for gold. Falling stock markets will play a critical role.
The GLD gold ETF is now formally called SPDR Gold Shares. Rising from modest beginnings nearly 9 years ago, it has grown into a dominant force in the global gold markets. This is because GLD acts as a conduit for the vast pools of US stock-market capital to easily and quickly flow into and out of gold bullion. These capital flows can greatly affect overall gold demand over short periods of time, buffeting gold’s price.
If GLD operated like a closed-end mutual fund, issuing a fixed number of shares one time at its IPO, this wouldn’t be the case. GLD would have zero impact on the gold price after its initial bullion purchase. But GLD isn’t structured this way, its primary mission is to track the gold price. And there is only one way to accomplish this. Both excess supply and demand of GLD shares have to be directly shunted into gold.
When stock traders get excited about gold, they buy GLD shares at a faster rate than gold itself is being bought. Thus GLD’s price rises faster than gold’s, and it threatens to decouple to the upside and fail its mission. In order to prevent this and bring GLD’s price back in line with gold’s, this ETF’s custodians have no choice but to meet this excess share demand. So they sell new GLD shares into the market.
Selling new GLD shares naturally raises cash. And the GLD custodians immediately plow these new funds into physical gold bullion held in trust for its shareholders in its London vaults. This process effectively shunts excess GLD share demand into gold itself, amplifying the underlying gold rally. So when stock traders are exerting differential buying pressure on GLD shares, it is very bullish for gold.
Ever since a gold ETF was conceptualized years before GLD was actually launched, both its advocates and opponents knew this tracking mission was a double-edged sword. Stock traders wouldn’t always buy ETF shares faster than gold itself was being bought. GLD would also face differential selling pressure from time to time, when its shares were being dumped faster than gold itself was being sold.
This reverses the bullion-holding process, pulling stock-market capital out of gold or effectively shunting stock-market GLD selling into gold. When traders sell GLD faster than gold is being sold, there is excess supply of GLD shares. So its price threatens to decouple to the downside and fail its tracking mission. In order to avert this, GLD’s custodians have to quickly absorb any excess supply of GLD shares offered.
They raise the cash to buy back these shares by selling some of the gold bullion out of their vaults. This of course increases the selling pressure on gold itself. So just like GLD differential buying pressure can amplify gold uplegs, GLD differential selling pressure can amplify gold corrections. Thankfully for gold bulls, we didn’t have to contend with a massive differential GLD selloff until this year. Boy was it miserable!
This first chart looks at the total GLD bullion holdings in metric tons superimposed over the gold price. GLD has always been extraordinarily transparent, publishing its total bullion holdings daily right down to the long list of serial-numbered individual gold bars. GLD’s holdings offer a fantastic window into stock-trader gold sentiment, showing when American stock-market capital is flowing into or out of gold.
For fully 8 years after its inception, which conspiracy theorists went apoplectic over, GLD was hugely beneficial for the secular gold bull. Stock-market investors and speculators alike bought GLD shares faster than gold was being bought, their capital literally flowing into this ETF’s underlying gold bullion as its custodians kept issuing new shares to maintain price tracking. GLD has been a great boon for gold!
In any bull market, its existing investors want as much capital as possible to flow in and drive up the asset prices they are betting on. The more the merrier, the more traders are bidding on an asset the higher its price ultimately goes. GLD provided a wonderfully easy and efficient (very low transaction costs) way for stock-market investors and speculators to participate in the secular gold bull. And participate they did.