ETFs Helped Fuel Gold's Boom -- and Could Worsen a Bust

Gold barsInvestors tend to treat financial markets as if they're timeless. Technical analysts, for instance, compare recent market patterns with those that occurred generations ago, and come up with historical ratios that are assumed to apply perpetually.

But markets have changed dramatically over time. The rise of computerized trading and virtual baskets of assets are leading stocks to trade in tandem and vexing professional investors who follow traditional approaches like value investing, for example. Investors would be particularly wise to look under the hood at the mechanisms that drive prices when it comes to gold, an investment that proponents ironically often push as a pure store of value.

However, a good deal of gold's meteoric gains over the last five years can be attributed to the gargantuan success of an exchange-traded fund (ETF) that made it easier than ever for investors to pile into the precious metal, The Wall Street Journal reports.

Launched in November 2004, the GLD (GLD) ETF is adding $100 to $150 per ounce to gold prices, experts tell the Journal. Industry body the World Gold Council (WGC) helped launch the ETF in a moment of "desperation," according to the Journal. Council backers that include gold and gold-mining companies were threatening to pull their funding because of the WGC's inability to boost gold prices, which had slumped for two decades prior to the recent rally.

"A Godzilla-Like Beast"

But GLD is now the fastest-growing major investment ever and has ballooned to $57 billion. GLD was created in part to help boost the demand for gold and attract new buyers. The investment vehicle has succeeded wildly in that pursuit. Between 60% and 80% of GLD investors are buying gold for the first time, according to WGC Managing Director Jason Toussaint.

But the Journal notes that "skeptics argue GLD could become a Godzilla-like beast if the gold rally reverses sharply." New gold investors, accustomed to nothing but rising prices, could flee if the momentum turns. And unlike assets such as stocks and bonds, gold has no income stream associated with it. And that makes valuing the precious metal almost impossible. Gold prices have rallied to about $1,400 this year. But they could just as easily be $140 or $14,000.

So far, the difficulty in determining prices has worked to the advantage of gold bulls. The precious metal can be hawked in anticipation of inflationary or deflationary conditions alike.

But while investors are told rising prices signal a recognition of gold's true value compared to fungible paper currencies, they should take a closer look at the dynamics of this market. The shady endorsements from paranoid media personalities and gold companies that push coins of questionable quality onto customers have already raised some eyebrows.

The rise of gold ETFs has also clearly helped boost prices. And if the momentum turns, that same ease of trading could lead to quick liquidation -- and prove to be a double-edged sword.

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tassnps

zerohedge.com: "Surge In GLD December $145 Call Volume While it is not surprising that 9 out of the top 10 option classes in GLD are calls, what is odd is that the most actively traded call by a substantial margin are the December $145 strikes. In other words, specs are betting that gold will move $60 higher in the next three weeks. Judging by today's 4% move in silver, the less valuable cousin may have a comparable move." http://www.zerohedge.com/article/surge-gld-december-145-call-volume

November 30 2010 at 1:47 PM Report abuse +1 rate up rate down Reply
groutguy66

You're kidding me right? "Gold has no value stream?" What's the value of not being able to hit an "on" switch and print billions of dollars out of thin air? How 'bout the "value" of a Worldcom or Enron when their boards are pulling financials out of their butts? The reason, idiot, that gold has risen so dramatically is that more and more people are coming to realize you cannot easily duplicate it or lie about it. You have to earn it! When you earn something it has value! When people feel it no longer has value they will sell it- just like millions of shares of worthless stock are every day! Your article sounds as though it was written by a high school student!

November 30 2010 at 8:21 AM Report abuse +2 rate up rate down Reply
Robert & Lisa

Look at the fundamentals folks. Record government spending and debt. George Soros's puppets, Obama and thugs in charge. I just don't see gold falling in price anytime soon. Maybe Vishesh is trying to talk the price down so he can buy some of your gold? LOL

November 30 2010 at 8:05 AM Report abuse +3 rate up rate down Reply
dad

IF YOU BELIEVE ANYTHING THIS GUY SAYS ABOUT GOLD,WELL,SHAME ON YOU,IT'S WELL-KNOWN THAT ONLY 2 PERCENT OF AMERICANS HAVE ANY INTEREST IN PRECIOUS METALS.CAN YOU GUESS THE DEMAND FOR THEM WHEN THAT 98 PERCENT START PANICKING OVER BERNANKE AND THE FED'S END GAME/ BILLY,BILLY,BILLY,BILLY

November 30 2010 at 12:58 AM Report abuse +3 rate up rate down Reply
Robert & Lisa

TIP's are why gold prices haven't gone much higher. The problem though with TIPS is, they are backed by the full faith in the FED which in my opinion becoming worth less and less by the day. Thanks, George Soros and his puppets, Obama and thugs.

November 29 2010 at 10:36 PM Report abuse +2 rate up rate down Reply
rivasernie

"Launched in November 2004, the GLD (GLD) ETF is adding $100 to $150 per ounce to gold prices, experts tell the Journal." You've gotta be kidding. How did they come up with a bold statment like rhat? How 'bout exposing these experts and start unmasking them one by one. As for our authot, Mr Kumar, he's got a lot to learn about the gold market, yet he can't bring himself to admit he underestimated the srength of the metal. Instead, I'm sure we'll see another article from him, stating that gold can't go any higher and smart investors should be looking for the exits. By then, the price should be at $1500.

November 29 2010 at 8:14 PM Report abuse +2 rate up rate down Reply
hello

Paul Weisenthal(former gold hater) writing about the WSJ article today says: "The Uber-popular SPDR Gold Shares ETF 'GLD' is the subjet of a long and fascinating profile in the WSJ titled:How a fund helped make gold prices glitter. The gist is that in 2004,gold was a dreary,forgotten asset and so the gold industry got together and democratized gold by creating an ETF that tracked the commodity and that since then there's been this huge boom. Now it is true that the ETF is now one of the biggest holders of gold in the world,and it is true also that gold has boomed since the launch of the ETF,but are the two related in any way? The evidence is not clear. As a test,we checked out gold in relation to copper and oil, two commodities that nobody thinks are strongly influenced by ETFs. What we see is two things: One is that the gold/copper and gold/oil ratios stayed pretty loww for quite some time after the creation of the ETF,even as the ETF grew 10x in amount of gold it held( it went from $1 billion worth of gold to $10 billion after two years,according to the WSJ). And even now, with gold near record highs, the ratios are firmly in line with historical norms. (thanks to Robert Wenzel over at economicpolicyjournal.com)

November 29 2010 at 7:23 PM Report abuse rate up rate down Reply
hello

Here comes the knocks and fear mongering against gold again. See gold is that canary in the coal mine that exposes government for the sham that it is(it's ponzi schemes,it's counterfeiting). You must remember that the bear market in gold(1980-2000) can be attributed to the many schemes governments divised to suppress its price. And the WSJ is famous for putting out hit pieces against gold. Where,pray-tell, did the WSJ ever tell it's readers to invest in gold now in it's ten year bull run-never. "GLD was created in part to help boost the demand for gold and attract new buyers". Or could it be said without the bias slant as-GLD was creatd in part to MEET the demand for gold and help new buyers intrested in investing.Period. Gold has no income stream unlike stocks and bonds because,like land, it is in a different investment category. It's like comparing apples and oranges. And is it really almost impossible to value the precious metal? Isn't the commodities market's moment to moment pricing of gold hard to value? Nuff said.

November 29 2010 at 2:25 PM Report abuse +2 rate up rate down Reply
bohemianacres

I agree. The price of gold went up too fast for its own good. Not only looking like the housing bust where intrinsic value was assest far too high and much too fast, mostly for the purpose of taxes on the local and state levels, gold is looking like the ultimate pyramid scheme where the bottom people will get stuck holding the debt lose. Especially when it looks like a scheme from the mining companies in the first place. When Alaska finally breaks open their mining operations, the bubble will pop.

November 29 2010 at 1:39 PM Report abuse -2 rate up rate down Reply
1 reply to bohemianacres's comment
Robert & Lisa

It's not gold going up in value but the dollar falling. Thanks, Obama and thugs.

November 29 2010 at 10:37 PM Report abuse +2 rate up rate down Reply
prognesub

How many ETFs promise delivery of the gold you think you own >

November 29 2010 at 12:51 PM Report abuse rate up rate down Reply