Surge in growth in gold ETF holdings has potential downside too

The phenomenal recent growth in gold ETF holdings is one of the factors behind the strength in the gold price, but it poses serious downside risks as well if sentiment changes. Meanwhile price movements are likely to remain volatile.

NEW YORK - 

Bullion held in depositories on behalf of gold exchange-traded funds investors is at record levels . . .  and, in recent days, has been growing by leaps and bounds.  Worldwide total gold ETF holdings now exceed 1325 tons (42.6 million ounces).

To put this number in perspective, ETFs now hold more gold than the Swiss central bank. Strikingly, gold held by ETFs now account for more than 40 percent of identifiable gold investment worldwide.

Gold ETFs are gold-backed stock-market securities representing ownership in a trust designed to track the ups and downs in the metal's price.  The principal advantage of gold ETFs is that they are bought, sold, and trade like stocks on an exchange.  However, ETF investors do not actually own physical gold. Although they are 100-percent backed by physical gold held mainly in allocated form, these securities do not give investors actual ownership with rights to take delivery of physical gold.

It is important for investors to remember that gold ETFs do provide exposure to the gold price - but they do not provide all of the special benefits of actual physical ownership in the form of bullion coins or bars.

Holdings of the NYSE-traded SPDR Gold Trust (NYSE symbol: GLD), the biggest exchange-traded fund backed by gold, hit a record high of 894.72 tons (28.77 million ounces) this past Tuesday - an increase of 1.5 percent from a day earlier and nearly 110 tons (3.54 million ounces) or 14 percent above the month-earlier level.  And, last we looked, other gold ETFs around the world together held over 430 tons (13.9 million ounces).

ETFS INCREASE MARKET VOLATILITY

The recent rapid rise in gold held by exchange-traded funds is both a cause and response to the sharp rise in the yellow metals price in recent months.  By facilitating gold investment for individuals and institutions, we are likely seeing significantly more investment demand than would otherwise be the case.  At the same time, recent high prices - and the uncertain, anxiety-ridden economic and investment environment - are attracting more investors to gold.

Importantly, the rapid growth of gold exchange-traded funds is a two-edged sword for gold, increasing volatility both up and down.  By facilitating gold investment and ownership by individuals and institutions they have, without a doubt, brought significant numbers of new participants to the market and boosted buying by veteran gold investors as well.

But let's not forget, the ease of investing in gold via exchange-traded funds is matched by the ease of disinvestment. Selling of gold by ETF investors is as simple and as fast as selling just about any equity or mutual fund.  Just as quickly as gold-ETF depository holdings have grown so might they shrink when sentiment changes.

This has already contributed to the increased short-term day-to-day gold-price volatility over the past year . . . and it is likely to contribute to the long-term cyclical volatility as well - with gold's ultimate cyclical high in the next few years much higher than most might now expect.

MORE ABOUT EXCHANGE-TRADED GOLD FUNDS

Originally listed on the New York Stock Exchange in November of 2004, traded on NYSE
Arca since December 13, 2007, SPDR Gold Shares now also trade on the Singapore,Tokyo, and Hong Kong stock exchanges.

Another, somewhat smaller gold ETF, the iShares COMEX Gold Trust, with holdings of 68.72 tons (2.21 million ounces) as of February 10th, is also listed on the New York Stock Exchange (NYSE: XAU).

In addition, other smaller gold exchange-traded funds are also traded on a number of stock exchanges around the world, including Australia, France, Mexico, South Africa, Switzerland, Turkey, the United Kingdom.

Jeffrey Nichols is Managing Director of American Precious Metals Advisors - www.nicholsongold.com

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