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Amidst
our seemingly endless slog through today’s dark sentiment wastelands
plaguing the markets, we have a birthday to celebrate. Four years ago this week, a
revolutionary ETF was launched that forever changed trading dynamics within
the global gold market. Known
today as the SPDR Gold Shares, GLD has been wildly successful by any measure.
GLD’s rise to fame has not been
easy. While a few contrarians
loved the idea of a gold ETF as a way to broaden
investor participation in this gold bull, many investors were very skeptical. Some were downright hostile. Although rehashing all these obstacles
GLD has faced is beyond the scope of this essay, I wrote about a gold ETF in 2002 years before GLD hit the market and also GLD itself in early 2006, late 2006, and late 2007. These past essays can still fill you
in on GLD’s history and dispel many myths
surrounding it.
GLD has
overcome much to become not only a juggernaut in the gold world, but in the entire
ETF world as well. This week, GLD
was the 3rd largest ETF on the planet with $18b worth of net assets (physical
gold bullion in its vaults)! Only
the SPY S&P 500 ETF and the EFA large-cap foreign stocks ETF were
larger. GLD is bigger than the
famous QQQQ NASDAQ 100 ETF, the DIA Dow 30 ETF, the XLF S&P 500 financial
stocks ETF, and the XLE S&P 500 energy stocks ETF. GLD is huge!
In order
to become the 3rd largest ETF in the US
out of a universe now exceeding 800, GLD’s
custodians have had to execute on their mission exceedingly well. GLD is simply designed to track the
price of gold. It grants stock
traders an easy and efficient way to add gold exposure to their
portfolios. As I’ve
discussed extensively in my past GLD essays, it is not a substitute for
physical gold coins as the foundation for a long-term investment
portfolio. But it’s not
meant to be. It is for
mainstreamers not well-versed in gold.
GLD’s advantages to traders are
legion. It can be bought and sold
instantly in any standard stock account, for trivial stock-trading
commissions. It can be shorted if
one expects a gold correction. A
high-volume and highly liquid GLD options market has also sprung up,
providing more sophisticated traders with excellent tools to exploit projected
gold moves via stock options. GLD
is inarguably the easiest and quickest way to get gold exposure.
And GLD’s contribution to this gold bull has been
massive as well, driving the gold price higher for all gold investors whether
they own GLD or not. It radically
widened investor participation in this gold bull, creating a direct conduit
for vast pools of stock-market capital to chase gold. And chase gold it has. As of this week, GLD held an amazing
749 tonnes of physical gold bullion in trust for its investors!
This is
a staggering amount of the yellow metal and difficult to understand without
context. Traditionally, the
largest gold holders are the national central banks of the world. Around 100 countries own gold
bullion. If you put GLD in this
list of elite central banks, it holds more gold today than all but 7! And after it merely grows another
2.1%, GLD will overtake Japan
to become the 7th largest gold holder on the planet.
But
although GLD is massive in the world of gold, it remains very small relative
to the financial markets. With
its $18b market cap this week, 118 individual companies in the S&P 500
are each bigger than it. This is even more impressive
considering these companies’ market caps were considered from severely
depressed end-of-October levels. The
top 20% of the S&P 500, the elite S&P 100 companies, collectively had
a $5935b market cap at the end of last month. So GLD has plenty of room to grow
despite its size.
By
acting as a conduit between stock-market capital and physical gold itself,
GLD has really changed the dynamics of the world gold trade. There are many other gold ETFs around the world, but GLD has something like 85% of
the total assets of all the world’s gold ETFs. It is the only individual gold ETF
that really matters. So in this
series of essays I have been studying GLD’s
ongoing market impact since its launch.
This
first chart plots GLD’s holdings since its
birth on November 18th, 2004. I
like to compare GLD’s gold bullion held in
trust with the performance of the price of gold, slaved to the right
axis. Not only is multiplying its
initial holdings by 94.3x as of mid-October utterly remarkable, but the way
these gold holdings have grown is fascinating. They have been far more stable than
even GLD’s most optimistic proponents
including me originally expected at launch.
While GLD’s holdings have indeed contracted modestly from
time to time, its strategic growth trajectory has been tremendously
impressive. GLD’s
gold has climbed in a somewhat stair-stepped fashion. Of course when gold is surging in a
powerful upleg, interest in gold investment is high
and GLD grows rapidly. But
provocatively even when gold is not surging, GLD still tends to grow
moderately on balance.
If you
carefully examine every sharp correction suffered by gold above, within them GLD’s holdings really don’t fall all that
much on a percentage basis. I
would have expected much larger declines during gold corrections when GLD was
born. Also interesting is GLD’s behavior during the
long, grinding, sideways consolidations in gold that bleed away
enthusiasm. It still exhibited
moderate growth during these slow times.
This performance is stellar, GLD is truly a
rock star.
To
understand why, consider how tracking ETFs
work. To match percentage moves
in the price of its underlying asset, a tracking ETF has to see similar
supply-and-demand pressures. But
supply and demand for GLD shares from stock traders doesn’t necessarily
match that of gold futures from futures traders. So in order for GLD to fulfill its mission, GLD’s
custodians must actively augment or retard GLD supply to ensure this ETF
tracks its underlying asset’s moves tightly. This isn’t easy.
If stock
traders demand relatively more GLD than futures traders are buying gold, GLD’s price will decouple from gold to the
upside. GLD’s
custodians have to vent this excess demand into the physical gold market in
order to equalize the demand pressure differential. So when GLD demand exceeds gold
demand, they issue new GLD shares and use the proceeds to buy physical gold
bullion. This works
simultaneously on two fronts.
Increasing GLD share supply absorbs the outsized ETF buying pressure
and then buying gold with the resulting stock-market capital forces its price
to rise more in line with GLD.
So
whenever you see GLD’s bullion holdings rise
in these charts, it means stock traders were buying GLD at a faster rate than
futures traders were buying gold.
And as you can see, outside of a few minor pullbacks GLD’s holdings have grown relentlessly. This means GLD is becoming ever-more
popular and stock traders are buying it up at a faster rate than underlying
gold demand. So GLD must issue
shares and buy gold to ensure this ETF keeps tracking gold closely.
Now
shunting stock-market capital directly into gold is wonderful when ETF demand
is expanding. It has accelerated
this secular gold bull. But the
massive pools of stock-market capital having access to gold
is a sharp double-edged sword.
If stock traders ever start selling GLD at a faster rate than gold
futures selling, GLD will be forced to contract its holdings. If it doesn’t, GLD will decouple
from gold to the downside and fail its mission.
If
excessive GLD shares are being dumped on the market and it is falling faster
than gold, GLD’s custodians have to buy back this excess
supply. Where do they get the
cash? By selling gold
bullion. This works two ways as
well. Selling physical gold
forces stock-market selling pressure on GLD into the physical market to
equalize the differential. And
then using the resulting proceeds to buy back GLD shares neutralizes the
excessive ETF selling pressure and keeps GLD tracking gold.
So when
(not if) a big disproportionate sustained GLD selloff happens in the future,
it will lead to gold falling much faster and farther than it would have if
stock-market capital wasn’t deployed in it. Personally I’m glad stock
investors can get gold exposure via GLD.
Yes, it increases upside and downside volatility. But this is typical as secular bulls
evolve. The higher a price goes,
the more capital gets interested in chasing it. The more capital flooding into a
market, the more volatility it generates. Even without GLD, gold volatility
would still gradually increase.
But
rather impressively, so far we haven’t seen the massive unwinding of
GLD positions that many gold investors understandably fear. GLD’s
holdings have grown steadily and relentlessly for 4 years running now. And this has happened through mighty uplegs, wickedly fast and brutal corrections, and long
grinding consolidations. As long
as demand for GLD continues to grow faster than demand growth for gold
itself, GLD will have to continue ramping up its vast holdings.
And with
GLD’s holdings running at just 0.2% of the
market cap of the S&P 500 at the end of last month, there is lots of room
to grow. As more stock investors
realize the importance of having some gold exposure in their portfolios, many
will buy some GLD shares. At 1%
of US portfolios, GLD would have to grow 5x bigger from here. This is not an aggressive or
unrealistic expectation within a secular gold bull. At 3% of US portfolios,
it would have to expand by 15x. This would make it the world’s
largest gold holder by far.
Many
hardcore physical-gold-coin investors, including me, have long wondered how
GLD owners’ resolve would weather a severe correction in gold. Would they panic and dump GLD,
exacerbating the decline in gold?
Or would they hold steady?
Since GLD is such a trivial part of the aggregate portfolio of all US investors,
maybe it is just too inconsequential to bother selling. At any rate, this past year was a
great test for GLD owners. Gold
was crushed, yet GLD still didn’t see disproportional selling. This chart zooms in.
When
gold powered from around $750 in October 2007 to just over $1000 in
mid-March, it is no surprise GLD’s holdings
were growing. Everyone,
especially non-contrarian mainstreamers, loves a hot investment. GLD’s
holdings grew to an all-time high of 664 metric tons. But gold cracked on a Fed rate cut
surprise (75bp instead of the 100bp expected) in mid-March and plunged 15.3%
by early May. Did this spook GLD
owners? Darned right it did! Check out the sharp drop in GLD’s holdings over this period.
Since
GLD owners were selling this ETF at a faster rate than the futures guys were
hitting gold itself, GLD’s holdings fell
12.6% over this span. Having this
giant ETF release 1/8th of its physical bullion into the market certainly
exacerbated this correction. But
interestingly as soon as gold stabilized, so did GLD’s
holdings. They held flat near
600t until mid-June when gold started rallying again. Remember that as long as GLD’s supply-and-demand trends match gold’s,
no changes in holdings are necessary.
From
mid-June to mid-July as Fannie Mae and Freddie Mac were failing, gold powered
12.6% higher. Even though gold
itself couldn’t best its $1005 mid-March high, GLD’s
holdings easily surged well above their March levels to new records. Over this same 5-week span GLD’s gold bullion held in trust soared by
17.5%! Stock traders were buying
GLD far faster than gold itself was rising, so this ETF’s
custodian shunted this excess demand into physical gold.
From
mid-July to mid-September, gold took a massive 23.8% beating. It was brutal, the worst correction of
this gold bull. If there was ever
a time for the “weak hands” owning GLD to panic, this was
it. And while GLD selling was
indeed excessive so its custodians had to sell gold bullion to buy back GLD
shares to maintain tracking, GLD’s holdings
still only fell 12.5%. This is
about half as much as gold fell, not too bad. GLD owners didn’t get as scared
as I thought they would in such a massive gold correction.
Gold
rallied strongly out of its mid-September lows. In fact, on September 17th it rocketed
11.1% higher on a single trading day!
It was one of gold’s biggest daily gains ever in percentage
terms. This extraordinary move
happening on a day when the S&P 500 fell 4.7% drove tremendous interest in GLD.
Stock investors flooded into it at a much faster rate than futures
traders were buying gold. That
day alone GLD bought 36 tonnes of gold, growing its hoard by 5.9%!
In early
October as the financial panic hit, gold got sucked into it. Everything
was sold due to margin calls, forced fund redemptions, deleveraging, and
fear. Sadly gold was sold as
well. I recently wrote an essay on this
curious selloff if you are interested.
From early October until this week, gold plummeted another 22.4%. If this didn’t terrify GLD
owners, nothing will. Here we had
a once-in-a-generation financial-market panic and gold failed to soar as
expected. Its selloff was a
terribly depressing development.
But GLD
owners didn’t panic. Their
resolve was very impressive. At
worst, GLD only had to shed 3.1% of its holdings during this steep gold
selloff! Even afterwards this
week, GLD’s bullion was still merely near
6-week lows and not far from its all-time high achieved in mid-October. If GLD investors were tough enough not
to panic in 2008, a
year of extraordinarily brutal and recurring gold selloffs, then I doubt they are a big threat in a more normal gold
correction not driven by an exceedingly rare global financial panic.
The net
result of all this? Check out the
trends on this chart. Gold itself
has been in a miserable downtrend since mid-March. It even fell under support in August,
September, October, and November.
Even long-time hardcore gold investors have had a tough time dealing
with this psychologically. Yet
despite such a rotten price and sentiment environment, GLD’s
holdings have been in an uptrend
this past year! Indeed GLD’s holdings soared to new all-time highs twice even after gold had started correcting
aggressively.
In
recent weeks, GLD’s holdings have been
discussed in contrarian circles. If
gold fell below a certain price, would GLD owners exit en masse? If they did, gold would plummet of
course. GLD would have to shed
gold fast to buy excessive GLD share supply. In a worst-case panic scenario, GLD
could conceivably dump hundreds of tonnes of gold onto the markets in a
matter of weeks. Some have
likened it to a “rogue central bank” due to this dire potential.
Is this
GLD-as-a-rogue-central-bank-like-selling-vehicle possible? Sure, anything is possible in the
markets. But is it likely? Certainly not if 2008’s strong
GLD holdings performance truly reflects GLD owners’ resolve. And this makes sense. Despite GLD’s
large size relative to gold, it is trivial relative to stocks. An average mainstream investor owns so
little GLD that it isn’t even worth worrying about for that particular
investor. GLD owners passed
2008’s tough tests with flying colors.
Another
way I’ve watched GLD evolve over the years is through its trading
volume. The more popular it gets,
the more its volume grows. This
is true both in terms of absolute share volume and capital volume. Capital volume is price multiplied by
share volume. Trading 10m shares
of GLD in the $40s is not the same as trading 10m shares of GLD in the
$80s. Traders’ interest in and usage of GLD is
soaring.
In
addition to the raw daily GLD share volume in red, this time I added a
quarterly-average-volume line in yellow.
This yellow line distills out a lot of the
random noise and shows the steady growth of absolute daily volume in
GLD. Interestingly it even
continued growing on balance in Q2 and Q3 2008 in the midst of
gold’s latest correction. Growing
volume is a sign of a healthy bull capturing the attention of more and more
traders. And of course capital
volume is growing even faster than share volume due to gold’s higher
prevailing prices over the lifespan of this ETF.
Provocatively
GLD had one giant volume spike that wouldn’t fit on this chart. On September 17th it rocketed to 66m
shares and the next day it remained incredible at 61m shares. As you can see, this is way beyond GLD’s precedent. What drove this superspike? In past GLD essays, I’ve
observed that big gold selloffs can lead to outsized GLD volume spikes. Gold plunges on a given day, GLD
traders get scared, and they sell aggressively.
But in
mid-September 2008, it was a monster rally
that drove GLD volume rather than a selloff. That was the day that gold soared
11.1% in its biggest daily rally in 28 years. This offers another important glimpse
into GLD owners’ psyches.
When gold soared, enough traders knew about GLD to buy it aggressively. This probably reflects a lot of latent
interest in this gold bull among stock traders that is usually
overlooked. GLD’s
custodians’ performance in keeping GLD tracking gold through such a big
and fast surge in demand is very impressive.
This
last chart explores the variance between gold itself and GLD. While it seems silly now after 4 years,
back in the initial months of GLD’s life
naysayers warned it would fail in tracking gold. They thought no one could be nimble
enough to actively shunt stock-market capital into and out of gold fast
enough to keep an ETF tracking this metal. Thankfully time has proven these fears
unfounded, just like most of the other fears surrounding this unique trading
vehicle.
Over its
entire lifespan, GLD’s daily correlation
r-square with gold has run a staggering 99.98%! And yes, this is the r-square and not
the raw correlation coefficient itself.
It simply could not be any higher. From a stock trader’s
perspective, for all intents and purposes GLD’s
performance was identical to gold’s. It has fulfilled its mission of
tracking gold’s movements perfectly. GLD is a great trading proxy for gold
itself.
Early
on, GLD tracked gold’s absolute levels more tightly than it does
today. The yellow line above is
the GLD price multiplied by 10, since each GLD share represents a tenth of an
ounce of gold held in trust. As
you can see above, this yellow line is falling farther behind the blue gold
line as GLD ages. This is totally
normal and reflects GLD’s expense ratio. All ETFs
charge a small fee for their services, and in GLD’s
case this is 0.4% per year.
In
return for providing the excellent trading vehicle that GLD has proven to be,
its custodians have the right to earn a reasonable profit from their hard
work. So each year they sell 0.4%
of this ETF’s gold to cover their expenses
and earn a profit. This
management fee is evident in GLD’s tracking
of gold. The red downtrend above
shows the 5-day moving average of GLD’s daily
variance to gold itself. Its generally
tight downtrend proves GLD’s custodians have
been doing an excellent job in keeping GLD aligned with gold.
This
variance downtrend is the direct result of that 0.4% expense ratio. If you go out 1 year after inception,
this downtrend is centered near -0.4%. At 2 years, it is around -0.8%. Not only is 0.4% a year very
reasonable for running GLD, there haven’t been any surprises. Like all ETFs,
GLD’s net-asset value per share is shrinking
slightly every year. But GLD is
still deftly fulfilling its mission of tracking gold and providing easy and
efficient access to gold exposure for stock-market capital.
Whether
GLD is something you own, want to own, or wouldn’t touch with a ten-foot
pole because you favor other forms of gold,
ultimately it has been very good for this gold bull. All gold investors, regardless of
their own investment preferences, want more capital to follow them into
gold. We don’t care where
this capital comes from, we just want the buying
pressure. By creating a conduit
between the stock markets and physical gold, GLD has succeeded in radically
broadening investor participation in just 4 years.
And as
long as this secular gold bull remains intact, GLD should only help gold on
balance. The financial panic has
driven up investment demand for gold, as GLD’s
soaring holdings amidst a falling gold price vividly illustrate. And global mined gold supplies were
already falling for years even before gold started correcting and the
financial crisis hit. With gold
miners’ decimated stock prices and the insurmountable difficulties in getting debt and equity
financing today, gold mined supplies’ contraction will accelerate.
On top
of this, according to Forbes the US government alone is on the
hook for $5 trillion in bailouts so
far! Much of this bailout money
will be created by the Fed out of thin air and eventually filter into the
real economy. And when it does, boy
inflation is going to skyrocket. If
you think GLD has been popular for the past 4 years, imagine how much more it
will be over the next 4 if headline CPI inflation doubles or triples thanks
to these asinine socialist bailout schemes? GLD should grow many times over from
here.
At Zeal
we have long been strategic investors and speculators unswayed
by irrational paranoia. Cold hard
facts are all that matter, not the endless permutations of wild conspiracy
theories. Years before any gold ETF existed, I wrote about how great one would be to broaden gold participation into the
mainstream. And since GLD
launched, I have fought the many silly myths used to scare investors away
from this innovative trading vehicle. GLD has been great for
this gold bull!
Today
more than ever, investors and speculators need clear thinking and sound
analysis untainted by the shrill emotions ruling the day. While the markets are illogical now,
they won’t be for long. Panics
never persist, but they drive great once-in-a-lifetime bargains that shrewd
investors and speculators can capitalize on. If you are tired of being ruled over
or unduly influenced by the shifting tides of popular sentiment, join us
today. Subscribe to our acclaimed monthly newsletter to grow your market wisdom!
The
bottom line is GLD has been a smashing success. By excelling in its mission of
tracking gold and providing an easy and efficient way to grant gold exposure
to mainstream stock investors, it has grown into the 3rd largest ETF on the
planet. And this is even more
impressive considering the heavy skepticism and
withering attacks on GLD launched from fringe factions within the
traditionally pro-gold community.
Whether
you or I would own GLD personally or not is irrelevant. The point is many nontraditional
gold investors have flocked to GLD and this trend should only
accelerate. Broader participation
in this gold bull, more capital from more origins bidding up gold, greatly
benefits all gold investors. And
as 2008 has shown, GLD owners aren’t anywhere near as skittish in a
gold selloff as many assumed they would be.
Adam Hamilton, CPA
Zealllc.com
November 14, 2008
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Copyright 2000 - 2006 Zeal Research (www.ZealLLC.com)
Information contained herein is obtained from
sources believed to be reliable, but its accuracy cannot be guaranteed. It is
not intended to constitute individual investment advice and is not designed
to meet your personal financial situation. The opinions expressed herein are
those of the author and are
subject to change without notice. The information herein may become outdated
and there is no obligation to update any such information. The author, 24hGold, entities in which they have an
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