Breakingviews: Exchange-traded funds add to gold's gyrations

Wed Apr 17, 2013 1:19am IST

A goldsmith waits for customers at a jewellery shop at the Grand Bazaar in Istanbul April 16, 2013. REUTERS/Murad Sezer

A goldsmith waits for customers at a jewellery shop at the Grand Bazaar in Istanbul April 16, 2013.

Credit: Reuters/Murad Sezer

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(The author is a Reuters Breakingviews columnist. The opinions expressed are her own.)

By Agnes T. Crane

NEW YORK (Reuters Breakingviews) - Exchange-traded funds have added to gold's gyrations this week. The yellow metal's swift decline - a 13 percent sell-off over two trading days - left investors breathless. Though it is still not clear what sparked the slide on Friday and Monday, stock-like ETFs added to the selling pressure. It's a reminder there's a dark side to making illiquid assets easier to trade.

Physical gold is difficult and expensive to move. But ETFs can be bought and sold like any other stock on an exchange while a fund's sponsor and its designated market makers manage the actual collateral. As a result, retail investors and hedge fund managers like John Paulson have plowed into paper gold. Last year, ETFs sucked up 279 tonnes of the stuff, a 51 percent increase over the prior year, according to the World Gold Council.

Notably, this demand didn't square with sentiment elsewhere. Jewelers and those who prefer their gold stacked neatly in a vault, not in a stock portfolio, bought significantly less last year than in 2011. That could suggest macro hedge funds and other investors were buying ETFs thinking central banks' ultra-low interest rates would bring inflation or, worse, destabilize the financial system. But that hasn't happened. And the same investors may now be bailing.

Though ETFs represent only a sliver of the overall gold market, their liquidity and transparency make them an obvious benchmark for sentiment. Moreover, the ability to add and shed holdings quickly - unlike, say, storing bullion in undisclosed locations - can exacerbate price swings. The largest U.S. gold ETF, State Street's (STT.N) GLD, for example, sold nearly 23 tonnes on Friday alone. That's double the amount of gold held by the central bank of Cyprus, which panicked investors after saying it may sell its reserves last week.

Such quick-fire trading comes with an additional cost. GLD shares traded at a 3 percent discount to the fund's underlying collateral on Friday and Monday, according to State Street's website. That's unusual for the ETF, which mostly tracks the value of its holdings closely. If such a discount were to persist, it could encourage more selling.

For the moment, calm has returned, with prices recovering slightly on Tuesday. But with more than $70 billion of assets in gold ETFs, investors should be ready for the next bout of volatility.


- On April 15, the spot price of gold for future delivery marked its worst two-day decline in 30 years, falling over 13 percent to $1,346 an ounce. Prices recovered somewhat on April 16, gaining 2.5 percent in afternoon trade.

- As of April 10, U.S. ETFs backed by gold have nearly $72.8 billion in assets, down 16 percent from the beginning of the year, according to Lipper.

- Collateral in State Street's gold ETF, known as GLD, has shrunk by nearly 200 tonnes from the beginning of the year. The ETF's price, which tracked the S&P 500 for much of 2012, is down nearly 20 percent for the year.

(Editing by Richard Beales and Martin Langfield)




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