An increase in the amount of gold bullion held by GLD (the SPDR Gold
Shares) and other bullion ETFs does not cause the gold price to rise. The
cause-effect works the other way around and in any case the amount of gold
that moves in/out of the ETFs is always trivial compared to the metal’s total
trading volume. However, it is reasonable to view the change in GLD’s gold
inventory as a sentiment indicator.
Ironically, an increase in the amount of physical gold held by GLD and the
other gold ETFs is indicative of increasing speculative demand for “paper
gold”, not physical gold. As I’ve explained in the past (for example, HERE), physical gold only ever gets added to GLD’s
inventory when the price of a GLD share (a form of “paper gold”) outperforms
the price of gold bullion. It happens as a result of an arbitrage trade that
has the effect of bringing GLD’s market price back into line with its net
asset value (NAV). Furthermore, the greater the demand for paper claims to
gold (in the form of ETF shares) relative to physical gold, the greater the
quantity of physical gold that gets added to GLD’s inventory to keep the GLD
price in line with its NAV.
Speculators in GLD shares and other forms of “paper gold” (most notably
gold futures) tend to become increasingly optimistic as the price rises and
increasingly pessimistic as the price declines. That’s the explanation for
the positive correlation between the gold price and GLD’s physical gold
inventory illustrated by the following chart.
Now, speculation in “paper gold” is both an effect of the gold price and
an important short-term driver of the gold price. It is therefore fair to say
that although changes in GLD’s gold inventory don’t cause anything, they
often reflect changes in speculative sentiment that at least on a short-term
basis do have a significant influence on the gold price. At the same time it
is also fair to say that the influence of speculative buying/selling in the
futures market is vastly greater (probably at least an order of magnitude
greater) than the influence of speculative buying/selling of GLD shares.
Refer to “The scale of the gold market” for details on relative
size an influence.
The speculative demand for “paper gold” has certainly ramped up over the
past several months. This is partly reflected by the increase in the GLD
inventory shown on the above chart, but it is primarily reflected by the rise
to an all-time high in futures-related speculation. This is illustrated
below.
Chart source: http://www.goldchartsrus.com/
The extent to which short-term speculators are bullish on gold is a risk.
An unusually-elevated level of speculative enthusiasm will never be the cause
of a reversal in the price trend from up to down, but it will exacerbate the
decline that happens after the price-trend reverses for some other reason.
