Gold Surges On Stock Selloff

Gold investment demand reversed sharply higher in recent months, fueling a strong gold rally. The big stock-market selloff rekindled interest in prudently diversifying stock-heavy portfolios with counter-moving gold. These mounting investment-capital inflows into gold are likely to persist and intensify. Both weaker stock markets and higher gold prices will continue to drive more investment demand, growing gold’s upleg.

Early in Q4’18, gold reached a major inflection point. It languished during the first three quarters of 2018, down 8.5% year-to-date by the end of Q3. Investors wanted nothing to do with alternative investments with the stock markets powering to new record highs. The flagship S&P 500 broad-market stock index (SPX) had rallied 9.0% in the first 3/4ths of last year. That left gold deeply out of favor heading into Q4.

But a critical psychological switch was flipped as the SPX started sliding last quarter. After long years with a little material downside, stock traders had been lulled into overpowering complacency. They were shocked awake as the SPX plunged 14.0% in Q4, its worst quarter since Q3’11. They poured back into gold as stocks burned, driving it a strong 7.6% higher in Q4! Rekindled investment demand was the driver.

Unfortunately, gold investment demand is rather murky. Gold is bought and sold every day all over the world, in countless venues ranging from major exchanges to tiny third-world merchants. Tracking even the majority of this in real-time is impossible. The best available data on global gold investment comes from the World Gold Council. But it is only published once per quarter, about a month after quarter-ends.

I can’t wait to see the WGC’s new Q4’18 Gold Demand Trends report due out in early February. These quarterly GDTs are very well done and essential reading for all investors. But while detailed and informative, their resolution is really low only being released 4 times per year. Investors need alternative data sources to understand and game what’s going on with gold investment demand between the GDTs, like now.

Thankfully there’s an excellent proxy of investors’ capital flows into and out of gold published daily, a high-resolution read. It is the physical gold bullion held in trust for the shareholders of the world’s dominant gold exchange-traded fund. That, of course, is the American GLD SPDR Gold Shares. GLD was created and launched by the World Gold Council way back in November 2004 and has grown into a gold juggernaut.

As part of the WGC’s GDT work each quarter, it tracks the world’s top 10 physically-backed gold ETFs. At the end of Q3’18 when you could hardly give away gold to American investors, GLD’s holdings still accounted for nearly 32% of the world’s top-10 gold-ETF total. Add in the 2nd-largest ETF which is also American, the IAU iShares Gold Trust, and these two leading ETFs control over 3/7ths of the global top-10 total.

The primary constituency for American gold ETFs is American stock investors. So what they are doing in terms of capital flows through GLD especially is exceedingly important for gold. In recent years most of the major quarterly moves in gold prices are nearly fully explainable by GLD’s holdings alone! They must be watched daily, as changes in them have proven the key to gold’s fortunes. It’s important to understand why.

The American stock markets are the biggest in the world, and American investors’ capital is vast beyond compare. At the end of Q3’18, the collective market capitalization of the 500 elite SPX stocks alone was a staggering $26,141.4b. By comparison, GLD’s total physical-gold-bullion holdings of 742.2 metric tons were only worth $28.4b. That’s less than 1/9th of a single percent, which for all intents and purposes is zero.

Thus if even the tiniest fraction of US stock-market capital migrates into or out of GLD shares, gold itself moves big. This dominant gold ETF effectively acts as a conduit between stock-market capital and gold. But as these colossal pools of capital slosh into and out of GLD, it is always at risk of failing its mission of tracking the gold price. The supply and demand of GLD shares and gold are independent of each other.

So differential buying or selling of GLD shares by American stock investors must be directly equalized into the underlying global gold market. This mechanism is simple in concept. When GLD shares are being bought faster than gold itself, this ETF’s price threatens to decouple from gold’s price to the upside. To prevent this, GLD’s managers need to shunt that excess GLD-share demand directly into gold in real-time.

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