With gold stocks languishing near lows in a desolate sentiment
wasteland, investors are wondering why this sector has fallen so deeply out
of favor.One theory is capital that would have traditionally flowed into
major gold producers has been diverted into the GLD gold ETF instead.Taken to
extremes, this logically leads to the conclusion gold stocks will never
thrive as long as GLD exists.Is it cannibalizing the miners?
Undoubtedly it is, so the real question is to what degree.Since GLDs birth in November 2004, it has grown into a wildly
successful behemoth holding a staggering $71.5b worth of physical gold
bullion in trust for its shareholders.I suspect the majority of GLD purchases
have been for diversifying large portfolios, for obtaining that necessary fractional
exposure to the gold price.GLD is fantastic for that.
In a parallel universe where GLD had never been conceived, some
fraction of the massive capital it has attracted inarguably would have flowed
into traditional gold exposure for
portfolio diversification.And that was buying shares in the worlds biggest and best gold miners, the ones that
dominate the leading gold-stock index (HUI).Thus the thesis that GLD is
cannibalizing the HUI is correct to some extent.
But traders have to be careful, as conspiracy theorists tend to
extrapolate this theory way too far.Despite GLDs
phenomenal success, there has always been a vocal minority that hate it with
a passion bordering on religious fervor.Rather than seeing GLD as a bullish
conduit for vast pools of stock-market capital to flow into gold and amplify
its bull, they believe it is a cunningly-devised fraud undermining golds advance.
While discussing these conspiracy theories is beyond the scope of
todays essay,
several years ago I investigated and debunked GLD conspiracy theories in
another comprehensive essay.Ive
also written extensively about GLDs impact in years
past.So if you need to get up to speed on the controversy that surrounds GLD in
some circles, read those earlier essays.They will put everything in
proper perspective.
Though GLD has to be cannibalizing the HUI, it cant be to the extent its detractors fear.The numbers
dont add up.In
early December 2012, GLDs
physical-gold holdings hit all-time record highs of 1353.3 metric tons.That
day they were worth $74.1b.Now if all the elite gold stocks that comprise the
HUI had a collective market capitalization less than that, you could make the
argument GLDs
cannibalization was major.
But just a week earlier at the end of November, the total market cap
of all HUI component companies was $190.4b.So there was still on the order of
2.6x as much capital invested in HUI gold stocks alone as the flagship gold
ETF.If you could magically transfer that $74.1b in GLD over to the HUI, its
market cap would only have risen 39%.While that isnt
trivial, it is far from being as apocalyptic as conspiracy theorists believe.
Consider this comparison from the HUIs
perspective.That indexs
bull-to-date high of 635 was achieved in early September 2011.Just a week
earlier at the end of August, the HUIs
total market cap was $246.7b.GLDs holdings were worth $73.9b the
day the HUI peaked.So if all GLDs
capital would have been deployed in gold stocks instead, the HUI would have
only been trading around 30% higher.
Thus even if we make the indefensible assumption that every
dollar ever invested in GLD would have gone into gold stocks if that ETF had
never existed, it would only have added about a third to the HUIs levels.That is nowhere near enough to account for
their underperformance.The HUI has been trading at panic levels
relative to gold in recent weeks, and would have to more than double
to hit its secular pre-panic average.
The raw market-cap numbers simply dont
support GLD overpowering gold-stock investment.Gold stocks as a group remain
far larger than the capital this ETF has attracted.But some would argue that
GLD has had an adverse psychological impact, and that may be
true.Where big fund managers used to have to buy gold stocks, to actually
think about this sector, now they can simply buy some GLD and call it good.
And since investing in gold stocks is far riskier than owning gold
itself, the ease with which GLD enables instant portfolio exposure to the
gold price may have short-circuited gold stocks traditional
role.But Ive always
subscribed to an alternative theory.Rather than shrinking interest in
gold-sector investment, I suspect GLD has expanded it dramatically.This
ETF is the ultimate gateway drug, growing the pool of capital chasing gold.
The more investment capital that flows into physical gold, regardless
of the vehicle, the higher its price is driven.And the higher golds price goes, the more investor interest it
generates.Everyone loves a winner, and golds
performance has been incredible over the past 8 years since GLD opened up a
direct conduit for stock-market capital to flow into physical bullion.And of
course higher gold prices help gold stocks.
Not only do they draw investors interest to the entire
precious-metals realm, they multiply the profits to be made wresting this
scarce resource from the bowels of the Earth.Last summer, the HUI gold stocks
were actually trading at their lowest price-to-earnings ratios of
their entire secular bull.The HUI was cheaper than it was during the stock
panics depths, and
considerably cheaper than the general stock markets!
Gold stocks are not suffering today because GLD is cannibalizing their
capital inflows, but simply because sentiment is at an unsustainable
ebb.Endless cycles of greed and fear echo through the markets.Prices soar to
overbought heights when greed gets excessive, and then correct
sharply.Eventually prices plunge to oversold lows and fear grows extreme.And
then this cycle begins anew.
When investors start regaining interest in the precious metals, they
pour capital into everything.It flows into the GLD ETF and gold stocks
simultaneously.If GLD was really diverting a major fraction of the
capital away from gold stocks, then the HUI wouldnt
perform well when GLDs holdings were
growing.But as this chart shows, that is certainly not the case.GLDs holdings and the HUI generally rise and drift together.
The red line is the HUI, the flagship gold-stock index.The blue one
shows GLDs gold holdings
in metric tons.When they are rising, it means stock traders are deploying new
capital in that ETF.When they are stable, no capital is flowing into or out
of GLD on balance.Buying demand and selling supply are roughly
matched.And when these holdings are falling, capital is flowing back out of
gold via GLD redemptions.
It is absolutely crucial to understand this dynamic.Remember the
mission of GLD is to track the gold price.This can only be achieved in
one way.Excess demand for GLD shares, or supply of them, has to be directly
shunted into physical gold or else this ETF will decouple from the metal and
fail.Its holdings only grow when it faces differential buying pressure from
stock investors, and only fall under differential selling pressure.
If stock traders are buying GLD shares faster than the gold price is
rising, then it will decouple to the upside.To equalize this excess demand
and keep GLDs price in line
with golds, the ETFs custodians issue new shares in large baskets.These
are sold into the market to sop up the differential buying pressure.The
resulting proceeds are then immediately invested in new physical gold
bullion, GLDs holdings
grow.
The opposite is true when stock traders are selling GLD shares faster
than the gold price is falling, it will decouple to the downside.GLDs custodians have to quickly absorb that excess
supply.To raise the cash to buy back their shares, they sell gold bullion.The
result is differential selling pressure through the ETF is shunted back into
physical gold as well.GLD is simply a two-way conduit for stock-market
capital to flow into and out of gold.
So realize when GLDs
holdings are rising, new capital is flowing into the gold market through this
ETF.When its holdings are falling, capital is flowing out.Once again if GLD
was diverting a major fraction of the capital that would have flowed into
gold stocks, the HUI would have the best chances of rallying when GLDs holdings werent
growing.But for nearly all of GLDs
existence, the opposite has proved true.
Gold stocks tend to thrive the most when GLD faces big differential
buying pressure and has to rapidly grow its holdings to keep tracking the
gold price.This supports my psychology thesis, that capital seeks all
precious-metals investments when gold is returning to favor.While the HUI may
have advanced more if GLD didnt
exist as an alternative, big GLD holdings growth certainly didnt eliminate massive HUI uplegs.
The chart above highlights them since the birth of GLD.Between May
2005 and May 2006, the HUI rocketed 136.9% higher in an awesomely profitable
upleg.If GLD had been cannibalizing gold stocks to the extreme degree
conspiracy theorists argue, such a major gold-stock surge couldnt have happened if GLDs
holdings grew rapidly.Yet they nearly doubled over that exact span, soaring
97.8% higher!
The next time gold stocks returned to favor in a major way led to a
71.5% HUI upleg between August 2007 and March 2008.Yet it wasnt an either-or scenario, as interest reignited in
gold capital flowed in all over this sectors
landscape.GLDs holdings
climbed another 28.8% over this span, from a much higher starting base.Soon
after 2008s crazy stock panic hit, crushing gold stocks radically
disproportionately.
Once it passed, GLDs
holdings grew dramatically in their biggest absolute surge of this ETFs entire lifespan by far.A handful of major hedge
funds were taking on massive positions in GLD, betting on the secular gold
bull continuing after the panic.GLD had never seen such intense differential
buying pressure before or since.Yet from October 2008 to December 2009 when
its holdings surged 51.0%, the HUI still blasted an amazing 236.9% higher!
Gold stocks next major upleg began soon after
the subsequent correction in February 2010.By September 2011, the HUI had
climbed 71.7%.Yet GLDs holdings
still grew by 11.5% over this span.It is interesting that their growth rate
slowed dramatically after the early-2009 hedge-fund buying frenzy had
catapulted them well ahead of their secular uptrend.And soon after GLDs holdings stalled, so did the HUIs advance.
Sometime in late 2010 or early 2011, investors
enthusiasm for the entire gold sector began to wane.So both the gold stocks
and the GLD holdings started to consolidate high.New capital inflows had
dried up universally for this entire sector, which makes sense in
psychological terms.It wasnt
like the HUI stalled because all the new capital was diverted into GLD.There
simply wasnt any new
capital for this entire sector!
After a brutal gold-stock capitulation
last spring, the great sentiment pendulum was pegged too far at the fear end
of its arc so greed had to return.The only way that could happen is through
rising prices, and the HUI indeed surged sharply between July and September
2012.Gold stocks blasted 35.6% higher over a short period of time where GLDs holdings also happened to edge up 4.0% to a new
all-time record.
See the pattern here?GLDs
holdings only grow when investor enthusiasm is returning for the entire
precious-metals sector.This same psychological phenomenon also ignited the
biggest uplegs in the gold stocks. HUI strength and stock-trader capital
inflows into GLD had a high positive correlation.They both thrive when
gold is returning to favor, and both slump later on when gold subsequently
falls out of favor.
Rather than being mortal competitors gleefully spilling each others lifeblood
so they can drink it, GLD and the gold stocks are in the same boat.They
thrive or wither together, battered about by the great greed and fear
cycles that cascade through gold.When a rising gold price starts winning
traders back and generating some excitement, there is more than enough
capital flowing in to lift all this sectors vehicles.
The key to gold stocks performance has always been gold,
and GLD functions similarly.This next chart looks at GLDs
holdings superimposed over the gold price.In general, this ETF experiences
the greatest differential buying pressure from stock investors when gold is
rallying smartly and returning to favor.Similarly when gold starts
consolidating or correcting, growth in GLDs holdings
stalls as new capital inflows dry up.
Other than the marginal new record GLD-holdings highs in recent
months, not much has changed on this chart since I last discussed this relationship in
depth a year ago.For our purposes today, just realize that GLDs
holdings grow the most when golds psychology is morphing from fear
to greed in major uplegs.This same sentiment shift drives big HUI
uplegs at the same times.GLD and gold-stock demand are both driven by golds
fortunes!
I started writing about a gold ETF a couple years before GLD
launched, and have always been very bullish on the idea.The more capital that
flows into any bull, the bigger it ultimately grows.So a gold ETF opening up
a new conduit for the vast pools of stock-market capital to easily
flow into gold would be a great boon for everything gold-related.It
would help ease new investors into this secular-bull sector.
In addition to being a gateway drug, a gold ETF provides a quick and
easy way for all investors to diversify into gold.Depending on how much
capital you run, buying gold coins isnt a
cost-effective way to own gold.If you have a $100k portfolio, putting 5% to
10% of your capital in gold coins is relatively easy.But if you are a hedge
fund or pension fund managing tens of billions, the coin market is too small,
illiquid, and expensive (high premiums over spot).
GLD fills that gap, allowing vast amounts of capital to be quickly
and cheaply deployed into physical gold bullion held in trust.That
portfolio-diversification mission has always been the primary market for
GLD.Because of the necessary management fees to operate this massive ETF, GLDs performance will always lag golds by 0.4% per year.This is acceptable to most money
managers since owning large amounts of gold themselves is prohibitively
expensive.
Gold stocks have an entirely different mission and constituency than
GLD.Their profits leverage advances in the gold price, leading to gains
in gold stocks that multiply golds
own when this sector is back in favor with investors.Instead of lagging golds gains like GLD has to, gold stocks can amplify
them by two times or even more in the right sentiment environment.I never
thought GLD and gold stocks directly competed.
Large money managers who want low-risk diversification are not
interested in the big additional operational risks gold stocks bear, and
investors and speculators who want big gold-sector returns arent interested in not even matching golds gains.GLD is great for portfolio diversification,
while gold stocks are great for investing in a secular gold bull.They each
attract in very different groups of traders controlling separate pools of
capital.
With such great differences in their risk-and-return profiles, odds
are GLD has cannibalized gold stocks considerably less than most traders
assume.While I am a big fan of GLD since it facilitates more capital pouring
into gold to amplify its secular bull, Ive
never owned it nor recommended it.But I have owned and recommended hundreds
of gold stocks over the 8 years since GLD was born.They are very different
vehicles for very different traders.
While weve always owned
and recommended physical gold coins as the foundation for every individual
investors portfolio, were stock guys at Zeal.We dont want to merely track golds gains, we want to far exceed them.And we have
through the contrarian trading of elite gold and silver stocks.Since 2001,
all 637 stock trades recommended in our newsletters have averaged annualized
realized gains of +33.9%!This doubled golds
compound annual return.
And with gold stocks so deeply out of favor again, now is a great time
to buy before the next major upleg explodes higher as greed returns.Our
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newsletters are currently full of high-potential gold and silver-stock trades
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!
The bottom line is the
gold ETF is not cannibalizing the HUI to any major degree.GLD remains much
smaller than the HUI components market cap, and its holdings grow the most when
gold stocks are also enjoying major uplegs.Capital flows into GLD and gold
stocks simultaneously when traders are feeling bullish and greedy on gold,
and dries up for both when psychology decays to worry and fear.
Both GLD holdings and
gold stocks have been consolidating for a couple years now, weathering the
fear end of the great sentiment pendulums arc.But
after such a long time being out of favor, greed is due up next in the
emotional cycles.And as gold returns to favor itself, gold stocks will rally
and new capital will drive up GLDs holdings
in parallel.There will be more than enough new investment to float all gold
boats higher.
February 8, 2013
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