Published: May 22 2011 19:22
The following news flash will only be controversial to a small, eccentric but vocal slice of the gold investing world: the bullion that backs wildly popular gold exchange-traded funds is real. Ditto for what governments claim to hold. There is no vast conspiracy. What is more, the leading gold ETFs are well designed and have proved resilient even in volatile times.
That is good news. But it also makes gold vulnerable to an unusual sort of selling pressure whenever it goes out of fashion. ETFs, led by the enormous SPDRS Gold Trust (GLD), today own about 2,000 tonnes of the stuff (equivalent to a quarter of US government official reserves). A loss in the popularity for the whole ETF concept of vicarious holding of the precious metal – the World Gold Council just reported rare outflows in the first quarter – could create much more pressure than is normal for an investment that loses buying momentum.
Why? Because the virtuous cycle of lowering barriers to entry for gold investing through innovations such as GLD would work in reverse. The ETF’s physical bullion (remember, it exists) would be dumped on to a market made up of a smaller group of investors, those willing and able to hold physical gold.
This physical market could be swamped. If just half the gold held in trust for ETFs were sold over three years, the amount available for bar and coin investors would increase by 50 per cent, based on their average demand of the past five years – and by 100 per cent based on the pre-bull market level of demand.
There should be no big problems for the ETFs and their marketmakers; they could operate safely in liquidation mode.
And physical buyers could be found to absorb the additional supply from the ETFs – at some price. But to clear the market, it is likely that the price would have to fall.
Predicting the top of the gold bubble is foolhardy. It is safer to predict that the bubble’s popping will be especially nasty.
Copyright The Financial Times Limited 2011
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