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Despite gold and silver consolidating in June, investment demand for
these precious metals remains robust.
This is evidenced by continuing growth in the bullion holdings of the
leading precious-metals exchange-traded funds. Both GLD’s and SLV’s
physical metals held in trust for investors have edged up to new all-time
record highs this month!
These popular precious-metals ETFs are radically changing the
investment landscape. They have
created conduits for massive pools of stock-market capital to quickly and
easily migrate into gold and silver.
They are enabling non-traditional PM investors, including pension
funds, mutual funds, and hedge funds, to instantly add PM exposure to their
portfolios. Since this is the
first time such vehicles have even existed in secular PM bulls, no one knows
what their ultimate impact will be.
But it should be revolutionary.
GLD, the world’s premier gold ETF, was only born in November
2004. Yet its meteoric rise since
has led it to become the most successful ETF in history. By the end of last month, GLD had
grown into the second-largest ETF on the planet (behind only the SPY S&P
500 ETF). No other ETF has ever
grown so big so rapidly.
Investors who cannot or will not participate in more traditional forms
of gold investing like coins have eagerly flocked to GLD to add gold-price
exposure to their portfolios.
And though SLV is even younger, launched in April 2006, it is
following in GLD’s big footsteps.
It is already on the verge of entering the elite ranks of the
world’s top 25 ETFs in terms of market capitalization. SLV is nearly as large as XLF and XLE,
the popular ETFs that track the financial stocks and energy stocks of the
S&P 500. This silver
ETF’s spectacular rise to prominence is second only to the gold
ETF’s.
Because these unique vehicles have greatly widened participation in PM
investing, they are fascinating and exceedingly important. No PM investor, whether they own these
ETFs or not, can afford to ignore their rapidly growing impact. If you’d like some background on
either, I’ve researched and written about both the GLD gold ETF and SLV silver ETF extensively.
These past essays explore these ETFs’ methodologies,
performances, limitations, and concerns in depth.
But today I want to concentrate on another aspect of GLD and SLV, their
“stickiness”. Before
these ETFs were launched, there was considerable opposition to them in the traditional PM investor
community. One concern among many
was that stock investors buying ETFs would be fickle, they would overtrade
and add to underlying metals volatility.
But interestingly, so far they really haven’t. Once stock investors buy GLD and SLV,
they have tended to stick with their investments.
This is evidenced by the bullion holdings of these ETFs. GLD and SLV are probably the most
transparent ETFs in the world, they provide extensive data on their
operations on a daily basis. This
includes reporting how much physical bullion they are currently holding on
behalf of their shareholders.
Charting this data over time yields valuable insights into PM demand
from stock investors.
Like all ETFs, the PM ETFs are designed to track the prices of their
underlying assets. To accomplish
this, their custodians must expand and contract the ETFs’ assets in
order to neutralize any differential supply and demand. Both gold and GLD have unique and
independent supply-and-demand profiles.
Just because futures traders are selling gold doesn’t mean GLD
shareholders are selling their ETF at the same rate. If differential
supply or demand develops, the ETF will decouple from its underlying asset
price and fail.
Consider SLV to illustrate this.
If there is a surge in demand for SLV shares without a corresponding
increase in demand for silver itself, SLV’s price will rise faster than
silver’s. But it is
supposed to track silver, not
decouple to the upside. So
SLV’s custodians will immediately issue new shares to neutralize this
excess demand. When investors buy
these shares, SLV’s custodians then use this new capital to buy more
physical silver bullion. This
mechanism shunts excess SLV demand directly into silver itself.
Opening such a conduit for stock-market capital is a double-edged
sword though. If differential SLV
selling develops, the ETF owners are selling faster than underlying silver
selling, the ETF will threaten to decouple to the downside. SLV share supply exceeds silver
supply. The custodian must buy
back these excess shares since market demand isn’t there. To finance these purchases, it sells
some of its physical silver. Thus
excess SLV selling bleeds into the underlying silver market as well.
The ETF holdings act like a sponge to smooth out surges and dips in
stock-market demand relative to underlying metals demand trends. When these holdings are growing, stock
investors are buying GLD and SLV at faster rates than futures traders and
physical users are buying gold and silver themselves. When these holdings are contracting,
stock investors are selling the PM ETFs at faster rates than the metals. So watching GLD’s and
SLV’s holdings offers great insight into stock-investor demand trends.
Now last autumn’s stock panic, the first in 101 years, was inarguably the scariest financial-market
episode anyone alive today has ever witnessed. In less than 4 weeks in October, the
flagship S&P 500 stock index plummeted 27%! Almost all investors were terrified,
the great majority truly thought the sky was falling. And gold and silver got sucked into
this maelstrom of selling too. It
was a universal bloodbath, brutal.
If there was ever an excuse for GLD and SLV shareholders to panic,
that was it. Over that exact 27%
19-trading-day stock-market-plunge span, gold fell 15% and silver 25%. The PMs certainly failed to live up to
their safe-haven reputations when general financial-market fear was the most
extreme. If GLD and SLV owners
were less committed, more excitable than investors directly owning physical
bullion, the stock panic would have revealed it. Yet the PM ETF owners held on during
this ultimate acid test.
The next two charts illustrate GLD and SLV holdings over the last 18
months or so, encompassing the panic and its aftermath. Physical bullion held in trust for ETF
investors is rendered in red off the left axes. The price action in the underlying
metals themselves is superimposed over the top in blue. The stickiness of PM ETF holdings in
the abyss, and their subsequent surge to record highs, is nothing short of
amazing.
Gold peaked just over $1000 in March 2008, the pinnacle of excitement
over the last 18 months for PM investors. After failing to break decisively
above this crucial psychological resistance, the metal consolidated sideways
until the bond panic of August.
The bond panic, like the stock panic that followed, led to massive
flows of flight capital flooding into the US dollar. This enormous dollar buying hammered
gold.
But despite gold’s generally weak behavior between March and
August, GLD’s holdings were pretty stable on balance. Yes, differential ETF buying demand
(GLD has to buy gold to equalize) was more likely when gold was
rallying. And differential ETF
selling pressure (GLD has to sell gold to sop up) was more likely when gold
was falling. But despite gold
rolling over and sliding down from around $1000 to $750, the GLD ETF holdings
remained sticky. GLD
shares’ supply and demand mirrored gold’s own pretty well.
The formal stock panic (VXO fear gauge staying above 50) started in
early October. Gold initially
fared quite well in this carnage, surging 10% to $916 in just 4 trading
days. But then the mass exodus of
capital fleeing into cash and Treasuries, driving up the dollar, caught up
with gold. The unprecedented dollar rally crushed it. Gold
plunged 22% over the next 5 weeks.
It was extremely disappointing to see this metal perform so poorly
during a stock panic, the very time it should have shined brilliantly.
I really expected GLD owners to get discouraged. Their faith in diversifying a fraction
of their stock portfolio into GLD for gold exposure (to counterbalance stock
risk) should have been shaken.
But amazingly, they held strong.
GLD’s custodians only had to sell 2.2% of its gold bullion over
the 5-week span where gold plunged 22% along with everything else in the
world (except the dollar).
GLD’s holdings were stable during the stock panic, there was no
differential selling pressure!
By mid-December when the stock panic formally ended and the extreme
fears started to abate, gold really caught a bid. Stock investors started buying GLD at
a faster rate than futures and physical traders were buying gold itself. GLD’s holdings broke above 800
metric tons for the first time ever in January. And they just accelerated from there,
soaring vertical and breaking 900t and 1000t in short order in GLD’s
best month ever in February.
That month alone, GLD’s holdings rocketed 22% higher! Demand for this ETF’s shares was
so great that its custodians had to buy 186t of gold bullion in the open
market. This was such a
fascinating episode that I devoted the entire March issue of our subscription
newsletter to it. Our current
Zeal Intelligence subscribers can download this “GLD Rush” issue
from the Archives section of our website. Because of the explosion of GLD demand
from stock investors, February was one of the most interesting months of this
entire gold bull.
At the time there was no way to tell who was buying GLD so fast, so I
used the generic term “stock investors”. But thanks to SEC filings in mid-May,
the biggest GLD buyer was finally revealed. It was one of the world’s
biggest, best, and most-highly-respected hedge funds! This fund, discussed in the current
June issue of Zeal Intelligence, bought an 8.7% stake in GLD by the end of Q1! It also bought large stakes in major
gold stocks. Elite mainstream
investors were flooding into GLD to get gold exposure in their portfolios, a
fantastically bullish development.
GLD had to buy so much physical gold so fast to keep this hedge-fund
buying from driving an upside decoupling that physical gold shot up just shy
of $1000 again. It was very
exciting at the time, even before we knew who was buying. GLD’s total holdings soared over
1000t, a huge milestone. But once
this elite hedge fund was positioned, the differential buying pressure
tapered off and gold started consolidating again.
After those February highs, gold spent a couple months drifting lower
then a couple months rallying. On
balance it has been a high consolidation, not very exciting. Yet during this time, GLD’s
holdings have still usually been stable or growing. Stock investors owning GLD not only didn’t sell it faster than gold
itself was being sold, but they bought and drove GLD holdings to new all-time
record highs of 1134t by early June.
To put this into perspective, according to the World Gold Council 2407
metric tons of gold were mined globally in 2008. So this GLD ETF alone, while
admittedly the world’s largest gold ETF by far, has already absorbed
the equivalent of 47% of an entire year’s worth of world mine
production! And GLD buyers are
not the hardcore investors who traditionally buy physical coins, but new
investors who probably wouldn’t or couldn’t invest in gold if the
GLD ETF hadn’t made it so quick, easy, and cheap.
Some investors, when they learn how massive GLD has grown, wonder if
it can possibly get any bigger.
But it still has vast room to grow. Every
investor should have at least 5% of
their investment portfolio allocated to gold. At the end of May, GLD had a market
capitalization of just $35b. On
the same day, the S&P 500 stocks had a collective market cap of
$8246b. Thus GLD was running just
0.4% of stock-market capital in the S&P 500 stocks alone. This ETF could grow 10x, from here, and still not hit the
minimum 5% gold portfolio allocation!
The stickiness of GLD’s holdings, and the increasing interest
large mainstream investors have in using this ETF to gain gold exposure, are very
bullish. As long as stock
investors are willing to buy GLD, it can continue to grow indefinitely. And as long as demand for GLD shares
grows, this ETF’s custodians will have to shunt excess demand directly
into physical gold. GLD buying
drives gold buying, which pushes gold higher, which gets more stock investors
excited to buy GLD. It’s a
beautiful virtuous circle!
While the SLV silver ETF wasn’t fortunate enough to see a major
hedge fund deploy into it like GLD, SLV’s holdings have still been steadily
growing. And these bullion
holdings have been at least as sticky as GLD’s. The stock investors buying SLV are
generally not selling it faster than silver itself when the metal is falling,
so SLV’s holdings are remaining stable during such episodes.
Of course the stock panic was the ultimate test of SLV owners’
resolve. If anything should have
spooked them, that would have been it.
From late September to late November silver plunged 34%. While it had been trading in the high
teens for most of 2008 before the panic, it was suddenly under $10 in October
and November. Yet even though
silver is highly speculative, SLV owners held strong. Over the span of this 34% selloff
SLV’s holdings only fell 0.6%.
Dead flat in the face of extreme silver fear!
Since the panic ended in mid-December, SLV has seen increasing
stock-investor interest just like GLD.
In February SLV’s total silver holdings surged above 250m ounces
for the first time ever. And even
when silver started consolidating with gold over the last 4 months or so,
SLV’s holdings stayed high.
Stock investors continued to buy SLV faster than silver was being
bought, driving a series of new record highs in its holdings. The latest was seen just last week, a
staggering 281m ounces!
To put this into perspective, according to the Silver Institute 681m
ounces of silver were mined worldwide in 2008. So SLV, barely 3 years old now, has
already absorbed the equivalent of 41% of an entire year’s mine
production. And just like GLD,
these SLV buyers are not traditional physical-silver investors. They are people and funds who
wouldn’t or couldn’t buy silver in its usual coin and bar forms.
This wouldn’t and couldn’t is important. Sure, every individual can buy
physical coins. But for many it
is just too much of a hassle.
They have to find a reputable coin dealer, learn about the coins, buy
the coins (paying a hefty premium over spot), and store the coins. For hardcore investors like me, this
is no problem. But for many newer
or casual gold and silver investors, the ability to add GLD or SLV to their
portfolios instantly for trivial commissions is irresistible. These ETFs are attracting new
investors, broadening PM participation.
Some investors, particularly funds, usually cannot buy physical
metals. Their charters explicitly
limit them to buying stocks. So
these new ETFs are the only way they can get PM exposure. Pension funds are deploying into GLD,
and probably SLV, to diversify in a way they traditionally
couldn’t. And even if some
elite hedge fund could buy physical, it probably wouldn’t want to. That fund that took such a massive GLD
stake in Q1 plowed nearly $3b into gold.
Where would a hedge fund physically and securely store $3b in
bars? It’s far easier to
let the ETF’s custodians store the gold, plus it can be traded
instantly in the future.
While I personally prefer traditional physical investing, my coins in
my own immediate physical possession, I am a huge fan of these new PM
ETFs. The more investors
“discover” gold and silver, the bigger their bulls will ultimately
be. These ETFs are creating a big
tent where everyone with a standard stock account can participate in these
gold and silver bulls. The more
the merrier, and the more profitable!
The more capital that has easy
access to gold and silver exposure, the higher these metals will ultimately
climb.
Still, there is one key thing lacking in these ETFs. Leverage. At best in GLD, an investor will
mirror gold’s performance less GLD’s 0.4% of assets annual
management fee. At best in SLV,
an investor will match silver’s gains less SLV’s 0.5% annual
expense ratio. For many
investors, especially those diversifying a small fraction of their total
portfolio into PMs, coming just shy of parity with the metals’
performances is just fine. But I
want to amplify the gold and silver gains.
So even though we currently have profitable short-term trading
positions deployed in both GLD and SLV in our newsletters, I prefer the gold
and silver producers. They have
immense profits leverage to the metals they produce. If silver goes from $15 to $20, silver
investors earn a 33% gain. But if
a silver miner is producing silver for a cost of $10 per ounce, and selling
at market, its profits double in
such a silver move. And
ultimately stock prices follow profits.
Thus gains in producer stocks far exceed their underlying metals’.
In our monthly and weekly subscription newsletters, we usually attempt to leverage expected
moves in gold and silver by buying elite producer and explorer stocks. This strategy has been exceedingly
profitable over the years. If you
are interested in investing and speculating in these secular gold and silver
bulls, with high-potential stock trades deployed when times look opportune, subscribe today.
On the silver-stock front, we just finished a comprehensive deep
research project looking at the universe of publicly-traded primary silver
companies. Over hundreds of hours
we whittled this list down to our dozen favorites. My business partner Scott Wright, a
world-renowned commodities-stock analyst, just finished an outstanding
33-page report detailing the
fundamentals of our 12 favorite silver stocks. In addition to being a fascinating
read, this awesome piece of work will get you up to speed on what we believe
are the best silver stocks in the world to own in this new post-panic
environment. Buy your copy today!
The bottom line is the investors buying the gold and silver ETFs have
been far more committed than anyone ever expected. Even during the most frightening
market episode of modern times, PM ETF selling didn’t materially exceed
the rates of selling in the underlying metals. Thus the ETF holdings have been
sticky, they’ve remained stable on balance even through sharp and scary
selloffs in gold and silver.
Part of this resilience reflects increasing mainstream stock-investor
interest in adding gold and silver exposure to their portfolios through GLD
and SLV. These ETFs’
expanding popularity has enabled both to grow to record holdings in recent
weeks even though gold and silver have been consolidating for months. And while GLD and SLV are already
large compared to the gold and silver markets, they remain very small
relative to the vast pools of stock-market capital. They still have lots of room to grow.
Adam Hamilton, CPA
Zealllc.com
June 26, 2009
Read
all articles published by Adam Hamilton
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