Gold-Price Indicator Fading as ETPs Tumble by $71 Billion

By Debarati Roy  

Gold-backed funds that heralded record prices in 2011 and last year’s biggest sell-off in three decades are becoming less useful as market predictors.
After a decade of changing mostly in tandem, gold prices and holdings in exchange-traded products backed by bullion have the most-negative correlation since 2004. Investment in ETPs are headed for a fifth straight week of moving in the opposite direction of New York futures, data compiled by Bloomberg show. That would be the longest stretch since 2012, before investors began dumping gold.
Global ETPs that accumulated more bullion than France’s central bank in 2012 saw their influence wane as equities surged and the Federal Reserve took
steps to ease economic stimulus, signaling higher interest rates that erode the appeal of gold as an alternative asset. As investors exited the funds, erasing about $71 billion of value, unrest from Ukraine to Gaza this year revived demand for the precious metal as a haven, boosting prices that Goldman Sachs Group Inc. says aren’t sustainable.
“There is a disconnect” because “a lot of money has left,” said Mark Luschini, the chief investment strategist at Janney Montgomery Scott LLC. in Pittsburgh that oversees $65 billion. “For gold, this year has been all about the Federal Reserve and political tension, and at the moment, the rate-increase worries are overshadowing the safe-haven buying.”

Opposite Directions

The amount of gold backing global ETPs has slumped 2 percent in 2014 to 1,727.6 metric tons on Aug. 26, touching a four-year low of 1.707.9 tons on June 20. Gold futures rose 7.7 percent this year to $1,295.40 an ounce on the Comex in New York. In 2013, the holdings plunged 33 percent while prices dropped 28 percent, the most since 1981.
Bullion rallied to start the year as unexpectedly weak economic growth sparked concern that the Fed would keep record-low interest rates, fueling inflation. Prices got another boost as war broke out between Israel and the Gaza Strip’s Hamas rulers, civil conflict expanded in Iraq, and tensions escalated in Ukraine following Russia’s annexation of Crimea in March.
Even as prices rose, the investor appetite waned. Open interest, or the total number of futures and options contracts not closed or delivered, shrank to a five-year low this month on the Comex, and volatility is near a four-year low. The Chicago Board Options Exchange Gold ETF Volatility Index, which measures the cost of options on the SPDR gold fund, the largest backed by the metal, is down 41 percent this year, touching a 15-month low in June.

Interest Cools

Investors have cooled on gold as the Fed took steps to ease stimulus measures, which helped spark last year’s plunge in prices. The central bank reduced its monthly bond-buying program to $25 billion on July 30, the sixth consecutive cut of $10 billion since November. Chair Janet Yellen said last week that if progress in labor markets “continues to be more rapid than anticipated,” interest rates may rise sooner than expected, and further increases could be more rapid.
The Standard & Poor’s 500 Index advanced 8.2 percent this year, reaching a record 2,005.04 on Aug. 26. The Bloomberg Dollar Index is up 0.8 percent, after a July rally that was the biggest in 14 months.
Gold will drop to $1,050 in 12 months, Goldman reiterated in a July 23 report, unchanged from its outlook to start the year. Hedge funds cut bullish bets on gold in three of the past four weeks, including a 13 percent drop in the week ended Aug. 19, U.S. Commodity Futures Trading Commission data show.
“The flows into and out of ETFs has been much less than last year,” said Tom Kendall, the research director at Credit Suisse Group SA in London. “Investors are more focused on the equity market, and the perception of systemic financial risk has come off considerably.”

Haven Asset

Gold-backed ETPs, led by the $32 billion SPDR Gold Trust (GLD), remain the most-held funds backed by a commodity and a popular purchase for investors looking for a hedge.
In July, with conflicts leaving thousands dead in Ukraine, Iraq and Gaza, holdings jumped 0.9 percent, the biggest gain since November 2012, data compiled by Bloomberg show. Precious-metals ETPs in the U.S. saw a net-inflow of $140 million this year, according to the data.
“Some people are slowly returning to buy gold as they feel the need for a haven asset and also realize that equities can’t keep rising forever,” Dan Denbow, a portfolio manager at the $1.1 billion USAA Precious Metals & Minerals Fund in San Antonio, said Aug. 25. “Steady buying of ETFs will translate into supporting prices in the long term.”
John Paulson, the billionaire hedge fund manager who is the largest SPDR holder, has kept his stake unchanged at 10.23 million shares for four straight quarters, according to government filings that cover the period through June 30.

Fewer Holdings

Paulson’s holdings are down about 68 percent since 2009, and he told clients in November that he personally wouldn’t invest more money in gold. George Soros and fellow billionaire Daniel Loeb sold their entire positions in SPDR Gold Trust in the second quarter of 2013. While investor sales have slowed this year, Barclays Plc forecast a drop of 100 tons from the gold funds in 2014.
“When you talk about factors influencing gold prices, changes in ETF holdings do not feature anymore,” said Sameer Samana, a senior international strategist at Wells Fargo Advisors LLC in St. Louis, which oversees $1.4 trillion. “We don’t think geopolitical worries will be a permanent concern, and a stronger dollar will push prices down. As prices start coming down, you will see retail investors start exiting the market again.”