Stock-market capital finally started flowing back into the flagship GLD gold ETF for the first time in 14 months in February. Though this buying was small, this is truly a momentous event. Extreme gold-ETF outflows were the dominant culprit behind last year’s epic gold selloff. Without that massive influx of additional supply weighing on the global markets, gold is going to surge on strong physical demand.
The World Gold Council’s latest Gold Demand Trends report published just a couple weeks ago really drives home the importance of gold-ETF selling. In 2013 they suffered their first net annual outflows ever seen since the first one was launched in 2003. As today’s secular gold bull is the first time these gold ETFs ever even existed, the gold market has literally never experienced anything like last year.
The WGC’s comprehensive supply-and-demand data, which is the best in the world, showed that gold-ETF outflows added a staggering 880.8 metric tons of gold supply last year! This was larger than the combined 678.5t physical demand increase from jewelry and bar-and-coin investment, so the gold price fell. Jewelry and bar-and-coin demand actually surged 16.5% and 28.3% last year, very strong growth!
But thanks to that huge gold-ETF supply, overall global gold demand fell 14.9% last year or 659.7t. Thus gold plummeted 27.9% to its worst annual performance in nearly a third of a century. And GLD bears the brunt of the blame due to its dominant size among gold ETFs. It saw a shocking 552.6t of outflows in 2013, a whopping 63% of total global gold-ETF outflows and 84% of the overall drop in global demand!
If American stock traders hadn’t fled GLD shares last year in a wildly unprecedented mass exodus on a colossal scale, global gold demand wouldn’t have slumped. And if gold prices had behaved normally in 2013, the selling from the rest of the world’s gold ETFs wouldn’t have happened. And neither would the resulting heavy selling in the global futures markets. GLD dug gold’s hole, and GLD will claw it back out.
So February’s shift to capital flowing back into GLD is supremely important, likely the vanguard of a major reversal. GLD is a tracking ETF, designed to mirror the gold price. So when American stock traders buy or sell GLD shares faster than gold itself is being bought or sold, this ETF will decouple from the gold price and fail its mission. The only solution to this problem is to equalize GLD-share supply and demand into gold.
So like all tracking ETFs, GLD acts as a conduit for stock-market capital to flow into and out of physical gold bullion. When stock traders are bidding up GLD shares faster than gold, GLD threatens to break away to the upside. So GLD’s custodians have to neutralize this differential GLD-share demand by adding more supply. So they issue new GLD shares and sell them, absorbing the excess demand.
They use the resulting cash to buy more physical gold bullion, growing GLD’s hoard. So whenever GLD’s holdings are growing, stock-market capital is literally flowing into gold through this ETF. This naturally boosts the global gold price, since more demand is being shunted into the gold markets. And its holdings relentlessly growing on balance was the story of this ETF before last year’s extreme anomaly.
ETF capital conduits between markets are a double-edged sword, amplifying the underlying asset’s downside as well as upside. When stock traders sell GLD shares faster than gold, this ETF is going to decouple to the downside. So its custodians quickly step in to sop up this excess share supply. They buy back GLD shares to maintain tracking, and the cash to do this comes from selling some of the ETF’s gold bullion.
So when GLD’s holdings are falling, stock-market capital is actually moving out of physical gold bullion. And as investors and speculators learned last year, this can happen on a massive-enough scale to overwhelm even large physical demand increases. Differential GLD-share selling pressure crushing the gold price was almost the entire gold story of 2013, which makes February’s buying so significant.
This first chart looks at GLD’s holdings superimposed over the flagship American SP 500 stock index (SPX) over the past year and a half or so. Stock traders were dumping GLD at dizzying rates to chase the Fed-driven stock-market levitation. GLD selling generally slowed dramatically during SPX pullbacks, and surged again when the SPX resumed melting up. That precedent makes February even more impressive.
Last month, there was enough differential buying pressure on GLD shares to drive a 10.5 metric-ton build in this ETF’s gold-bullion holdings. These capital flows from stock markets to gold are still small, worth just $441m at February’s $1301 average gold price. And on this chart, the upturn is barely a blip. But it was still enough to push gold 6.5% higher, which was this metal’s best month since July 2013.
February 2014 was GLD’s first holdings build in 14 months, since December 2012. Its 10.5t was the largest absolute holdings build since November 2012, and its 1.3% gain was the best seen since way back in September 2012. In each of those three months, the gold markets were still normal with prices averaging $1684, $1722, and $1749. 2013’s epic sentiment-cratering slaughter hadn’t happened yet.
10.5t looks trivial on this chart because American stock traders’ gigantic mass exodus from GLD shares sucked an astounding 563.8t of gold out between December 2012 and January 2014. From its holdings’ all-time record high in December 2012, they plummeted by 41.7% in just over 13 months! Before that, the biggest draws GLD had ever suffered maxed out at merely 129.1t and 13.0% in two separate events.
So 563.8t and 41.7% is an outlying draw so extreme it defies superlatives. American stock traders chose to abandon gold (via their GLD positions) because of the amazing stock-market levitation. Through both its enormous QE3 bond-monetization campaign and parallel jawboning, our central bank worked to convince stock traders that they had nothing to fear. The Fed would step in to head off any major selloff.
This so-called Fed Put made stocks the only game in town. Alternative investments like gold lost their luster, and the essential and prudent concept of portfolio diversification was tossed out the window. The professional money managers no longer worried about losing their customers’ money thanks to the Fed’s effective backstop, they instead started intensely fearing falling behind their peers’ performance.
So they aggressively bought what was rising, general stocks, and dumped what was falling, gold. This quickly became a vicious circle for gold. The more it was sold, the farther its price dropped. And naturally the lower its price went, the more GLD shareholders were scared out of their positions. So month after month after month, stock capital flowed out of GLD at staggering rates as this chart reveals.
This inverse correlation between the stock markets’ performance and GLD’s holdings is readily apparent. While there are occasional exceptions driven by specific gold events I’ve discussed in much depth in past essays, for the most part GLD differential selling accelerated when the SPX was melting up. This is especially true in the second half of 2013, after April’s panic-like gold plunge had passed.
When the stock markets were levitating, GLD-share selling intensified. The stock traders who held GLD shares were tempted enough by the general-stock gains to rotate capital out of gold into stocks. And then when the SPX pulled back in one of its periodic minor selloffs, GLD’s holdings would stabilize or even start rising like in August. The light-red shading above highlights these SPX pullbacks visually.
GLD’s holdings first appeared to be bottoming and reversing in August, thanks to a sharp SPX pullback. And then after getting dragged even lower by the greedy stock psychology brazenly nurtured by the reckless Fed, they look to have bottomed and reversed again in January as another sharp SPX pullback was getting underway. Interest in and demand for alternative investments grows when general stocks droop.
Understanding this past year’s strong inverse relationship between SPX performance and GLD-share demand is essential to grasping the significance of February’s GLD build. Last month’s GLD capital inflows weren’t only the first and biggest since late 2012, they happened in a month where the SPX was exceedingly strong! It rocketed 4.3% higher, its best month since October when the partial government shutdown ended.
Now after last year’s precedent, you’d think that any differential buying pressure on GLD shares would require a significant stock-market selloff. Yet stock capital still flowed back into gold bullion via the conduit of this flagship gold ETF despite a big SPX surge to new nominal record highs. This strongly suggests that the GLD selling is exhausted, that all stock traders who wanted out of gold have already exited.
So what will happen to demand for GLD when the overbought, overextended, overvalued, and euphoric stock markets inevitably roll over? Odds are it will soar! Not only has gold always been a safe haven in times of market weakness, it is probably the world’s cheapest asset class after last year’s epic selloff. So investors and speculators won’t only gain diversification through gold, but large gains as it mean reverts higher.
Next page: Supply, Demand Data