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Gold ETF Mass Exodus

Adam Hamilton
Jan 27, 2012

Gold is enjoying an awesome January, rallying strongly out of its oversold late-December lows. But last month's hyper-pessimistic sentiment deserves some reflection before it totally fades from memory. One of the core theses of the bears resolutely predicting sub-$1400 gold prices soon was the notion that there would be widespread liquidations in the flagship GLD gold ETF, a mass exodus of capital.

If it indeed came to pass, gold would almost certainly be considerably lower than we've seen in recent weeks. But it didn't, the stock traders owning GLD didn't panic and rush for the exits as feared. Instead they boldly stood their ground, continuing the long tradition of GLD shares being held in strong hands. GLD's entire history shows its owners largely want gold exposure for the long haul, they aren't flighty.

Just as mass-GLD-liquidation fears captured mindshare in past gold corrections, they are certain to once again become popular bearish centerpieces in future ones. So gold investors and speculators alike, whether they own GLD or not, need to understand this mighty ETF's track record during gold corrections. This critical knowledge will mitigate mass-exodus fears in future gold corrections, reducing the odds of getting suckered into selling low by the bears.

Thanks to wacky conspiracy theorists never ceasing to irresponsibly spout utter nonsense about GLD, it still isn't as well understood as it ought to be by now. Holding a staggering 1259.6 metric tons of physical gold bullion in trust for its owners these days, worth a colossal $69.3b, GLD is a massive force in the gold market. Its price impact on gold since its birth 7 years ago in November 2004 has been enormous!

GLD acts as an incredibly-important conduit for the vast pools of stock-market capital to easily flow into and out of physical gold bullion. It opened up gold investing to a huge new market, including pension funds, mutual funds, and hedge funds, that never would have gone through the considerable hassles and expenses of buying gold coins. GLD is a frictionless, cheap, and easy way to get gold exposure.

The operational mechanisms of this conduit are easy to understand. When a stock trader wants some gold exposure in his portfolio, he buys shares in GLD. Each share represents 1/10th of an ounce of gold, less a modest 0.4% annual expense ratio necessary to move and store the physical gold bullion and pay the people running this ETF. If there happens to be a GLD seller right then, the shares change hands without anything happening to GLD's underlying bullion holdings.

But usually there are more buyers of GLD shares than sellers, or vice versa. Remember that GLD's mission is to track the gold price, so if this ETF's real-time supply and demand isn't synchronized with gold's then their prices will disconnect. In order to avoid failing, GLD's custodians have to directly shunt excess GLD-share supply or demand directly into gold bullion. They do this as necessary in 100k-share increments, which equalizes differential price pressure and keeps GLD shares synchronized with gold.

Most of the time since GLD's launch, there has been more demand for GLD shares than supply. If these buyers bid up GLD shares and the custodians do nothing, GLD's share price would decouple from gold to the upside. To bleed off this excess demand into gold itself, the custodians issue enough new GLD shares to sop up the differential demand. Then they take the capital raised and promptly buy physical gold bullion to put in their vaults that very day. So excess GLD demand shunts capital into gold itself.

But sometimes, and this is what the bears worry about during corrections, GLD-share supply exceeds demand. If the GLD sellers dump their shares faster than gold itself is being sold, this ETF's price will decouple from gold to the downside. GLD's custodians must quickly absorb this differential supply. And the only way to raise the capital necessary to buy back the excess shares offered is by selling physical gold bullion. As these funds repurchase GLD shares, excess GLD supply is shunted into gold itself.

So GLD's holdings, the amount of physical gold bullion it holds in trust for its investors at any given time, are a reflection of the supply-and-demand dynamics of GLD shares relative to gold's own. Thankfully GLD has been extraordinarily transparent since its debut, publishing its physical-gold-bullion holdings in great detail (down to individual bars' sizes and serial numbers) on a daily basis. By charting this priceless data, we can better understand how stock traders interact with gold via the conduit of GLD.

This first chart looks at the entire history of GLD's holdings along with the gold price. The first thing that sticks out is the remarkable growth in this ETF's gold hoard, it has been wildly popular with stock investors. Note also that GLD's holdings tend to be "sticky". Once they grow to any new level, they are rarely sold back down again. GLD's owners are some of the strongest hands in the whole gold realm.


When GLD was born in November 2004, the goofy conspiracy theorists went nuts. They were utterly convinced it was some kind of convoluted and nefarious scheme to cap the gold price. But with gold trading around $450 when GLD was launched, they couldn't have been more wrong about this ETF being bad for the gold bull. As I explained two years before GLD was even launched, opening up a direct conduit for stock-market capital to buy physical gold bullion was wildly bullish for this metal.

GLD's popularity was apparent right out of the gates, as relentless differential buying pressure on its shares forces its custodians to continue buying bullion. This shunting of stock-market capital into gold led to gradual, consistent growth. And though GLD's holdings saw some nice spikes early in major gold uplegs, they pretty much ignored gold corrections. As a group, GLD owners didn't dump GLD shares much faster during gold corrections than gold itself was being sold. So its holdings rarely shrunk much.

The ultimate test of the resolve of GLD's owners was during 2008's brutal once-in-a-century stock panic. Gold itself was very disappointing over this span, as everyone believed its safe-haven nature should have led it to soar. Instead it plunged 29.3% between March and November 2008, with 9/10ths of this brutal selloff happening in less than 4 months from July on! If there was ever a reason for GLD owners to panic and dump their shares en masse, that was it.

But they didn't, even in the greatest hellstorm of fear we'll see in our lifetimes! GLD's holdings did swoon a couple times, but even at their panic nadir in September were only down 2.2% year-to-date. Whenever the gold bears bring up the threat of a mass exodus from GLD during a gold correction, my first question centers around this panic behavior. If the biggest and scariest gold plunge of this entire bull didn't spook GLD owners, why should a mere garden-variety correction?

Up until early 2009, GLD's holdings had climbed in a nice straight line, even through the panic. But this secular uptrend was broken to the upside when some major hedge funds started making massive bets on the gold price via GLD in early 2009. The resulting surge in holdings was gigantic as you can see on this chart. And out of all major investors, hedge funds have the well-earned reputation of being the most capricious and flighty. They don't hesitate to get into and out of trades quickly.

Yet even with this perfect opportunity to see heavy differential selling pressure spill out of GLD into gold itself, it didn't happen. Once GLD's holdings got to those incredible hedge-fund-buoyed levels over 1000 metric tons, they pretty much stayed there. They are sticky once new levels are reached, material differential selling pressure is rare. Even during a sharp gold correction starting in late 2009, when gold swooned 12.6% in just over 2 months, GLD's holdings only contracted 2.4%.

While it is true GLD's holdings didn't grow during much of 2009 and 2010 after reaching new highs, there were still no material selloffs. Demand for GLD shares was so high among stock investors that any selling, even of elite-hedge-fund magnitude, was easily absorbed by other buyers. GLD's holdings continued to gradually climb on balance, slowly drifting back towards their original secular uptrend.

Then last summer, gold rocketed higher in an anomalous summer surge. Just before it topped near $1900 in late August, I publicly warned that it was very overbought so a major correction was due. I even pointed out that if it corrected back to its 200-day moving average, highly probable in a major correction, gold could fall 18.1%. This contrary opinion was wildly unpopular in August, so I got a deluge of hate mail. Everyone wanted to believe all the silly gold-to-the-moon hype so characteristic of a major top.

But not surprisingly gold did indeed correct. No bull, no matter how strong, is immune from the necessary rebalancing of sentiment after prices run too far too fast and greed grows too extreme. As I had warned the trading day before gold topped, this correction was sharp. This metal plunged 18.3% in 4.2 months, finally bottoming again in late December. Of course this correction adeptly did its job of completely swinging the great sentiment pendulum to the opposite extreme. Hyper-bearishness reigned.

And that hyper-bearishness that plagued gold in the second half of December is why I decided to write this essay. I started trading stocks at 12 years old, and have been a contrarian speculator most of my life. And in writing publicly about the markets since 2000, I am acutely aware of how much people utterly hate to see contrary opinions near major tops and bottoms. They want to believe a topping market is going to shoot higher forever, and a bottoming market is going to plunge forever. Linear assumptions rule.

So if I had written this essay in December, few would have read it except the hotheads clogging my e-mail inbox with all their vitriol about how stupid I am. But today a few weeks after that hyper-bearishness, everyone still remembers it but they can finally step back from their emotions and view it more objectively. Was there a GLD mass exodus during this recent major correction as the gold bears breathlessly screamed about in December? No, as usual they were dead wrong. Being bearish after a selloff is useless.

Over that 4.2-month span were gold corrected 18.3%, GLD's holdings once again shrunk by a trivial 2.3%! Just as they were during the stock panic, just as they were during prior gold corrections, GLD owners once again proved to be strong hands. As a group they are mostly large funds, run by managers who wisely want some long-term gold exposure in their portfolios. The cold, hard fact is GLD's holdings have never materially plunged during any gold correction so far. Yet the bears still trumpet this idea near lows.

This next chart zooms in to just the past year or so. Of course the GLD holdings look far more volatile without a zeroed axis, but realize from the first chart that these fluctuations are pretty immaterial in the grand scheme. There are definite interactions between GLD and gold during some of this metal's sharp surges and selloffs, but for the most part GLD's holdings remain stable and sticky near highs.


I almost didn't run this second chart, lest it be used out of the crucial context of the first. Realize that the entire right axis only spans about 1/8th of GLD's total holdings. So all the wildness apparent in this ETF's physical-gold-bullion hoard at this scale is fairly inconsequential relative to its total holdings. Nevertheless, magnifying these interactions offers new insights into GLD's impact on gold.

Provocatively the big surge in GLD's holdings in July was the catalyst that launched and accounted for the majority of gold's huge, sharp, and atypical summer rally. Stock traders were increasingly attracted to owning gold as they grew more nervous about the lack of progress on Congress's debt deal to rubber-stamp Obama's unprecedented profligate spending. GLD's holdings peaked on August 8th, the first trading day after Standard and Poor's downgraded the USA's credit rating for the first time ever.

But though Obama's record federal-debt growth forcing this event was very discouraging to Americans, the sky wasn't falling in the markets as everyone feared. So some of the short-term traders who flooded into GLD in July and early August started to exit. A deluge of shares hit the markets in late August, more than there were immediate buyers for. So GLD's custodians had no choice but to sell bullion and use the cash raised to sop up this differential selling pressure by buying back excess GLD shares.

As soon as this initial GLD selling ran its course, gold rebounded again on heavy futures buying. But it was very overbought as I warned at the time and soon started correcting hard. But even during its sharp selloff in September (exacerbated by a big US dollar rally), there was no mass exodus from GLD. GLD's holdings actually spiked higher a bit during that selloff, its share demand was higher than supply!

After holding strong through the worst of the recent correction's selloffs, GLD's holdings started surging again in early November as rallying gold prices enticed more stock traders into buying GLD shares than were selling. GLD's custodians had to sell new shares to meet this demand, otherwise GLD would decouple from gold. The cash raised was immediately shunted into physical gold bullion. By the end of November, GLD's holdings were nearing August's highs again!

But unfortunately gold's initial sharp correction wasn't enough to fully eradicate the excessive greed and euphoria of early August. So when the dollar started surging again in December, gold suffered a second sharp downleg. During this one GLD's holdings did indeed start falling. In a psychologically-challenging 3-week span in December, gold plunged 11.2%! This is that final period highlighted in red above, where the GLD selloff you can see is what got the gold bears all worked up about a GLD mass exodus.

While that GLD-holdings selloff looks significant at this tight scale, in reality this ETF only liquidated 3.2% of its physical gold bullion. This was still well below the materiality threshold of 5%. And there were good reasons to sell in December. Even late in its correction, gold was still up about 10% year-to-date while the S&P 500 was dead flat. So some early buyers realized profits. Others sold to raise cash to cover losses in other markets. And the suckers who bought into that euphoric surge in late July and early August probably wanted to lock in tax losses.

Now in the gold bears' defense, some day there almost certainly will be a mass exodus from GLD. And it is going to just crush gold. But I suspect we are still years away from that reckoning, as gold's fundamentals remain so dazzlingly bullish that its secular bull likely has years to run higher yet. Global gold demand continues to grow far faster than mined supply, and investors remain very under-exposed in this asset as a quick calculation reveals.

The flagship S&P 500 stock index, the 500 biggest and best American companies, had a total market capitalization around $12,485b in the middle of this week. Meanwhile GLD, while colossal in the gold world, only held $69b worth of gold. So we are talking about merely 0.5% to 0.6% of the capital in the S&P 500 alone being deployed in this leading gold-investment vehicle. What is a prudent level of gold exposure for an average portfolio? 5%? 10%? Gold investment still has vast room to grow!

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The bottom line is the recent bearish arguments for a mass exodus of capital from GLD were pure hype. Though such an event would indeed hammer gold, in the entire 7-year history of this ETF it has never seen serious differential selling pressure. No gold correction, no matter how sharp or large, scared away GLD's owners. Not even 2008's stock panic, with its terrible impact on gold, ignited major GLD selling.

Given this long track record of GLD holdings' stickiness and its owners' strong hands, there is no reason to fear a GLD mass exodus in any gold correction. As long as gold's fundamentals remain bullish, global demand growth outstrips supply growth, and as long as investors remain underexposed to gold, GLD's physical gold bullion held in trust for its owners is highly likely to continue growing on balance.


Jan 27, 2012
Adam Hamilton, CPA

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