WGC: Gold Fundamentals Strong, ETF Outflows Remain A Risk

by: Gary Bourgeault

With over a decade of straight positive gains for the price of gold, it was inevitable that there would be a correction, and we're in the middle of that right now. But the latest report from the World Gold Council concludes the fundamentals supporting the price of gold remain in place.

Marcus Grubb, Managing Director, Investment, at the World Gold Council, said this in the report:

Overall, the long-term appetite for investment remains strong, demonstrated by the continued demand for bars and coins."

As to the reason behind the outflow in gold-back ETFs, Grubb added, "Gold-backed ETFs, which made up 6% of gold demand in 2012, have seen some holders, primarily in the US, collect profits and move into equities. While gold ETF holdings are down, this has been balanced by 378t of investment in bars and coins, an increase of 10% on the same period last year, and up 12% on Q4 2012."

This confirms my conclusions concerning why a gold rebound should continue over time and physical gold support could be a counter against gold-backed ETF outflow downside risk.

Including gold ETF outflows, physical gold demand dropped 13 percent year-over-year.

The Gold Contraction Narrative

Some investors have put forth a number of theories as to why the price of gold has plummeted, with some of them being quite creative and detailed. I think a lot of that has been generated from the frustration of the depth of the contraction in the price of gold while the fundamentals in the sector remain intact.

The explanation by the World Gold Council, overall, I believe is the major reason. It's not much more than investors moving money out of gold and into equities because of the current confidence level in stocks, whether it's warranted or not.

That's not to say there hasn't been some efforts to manipulate the price of gold, but in general it's the market driving gold prices at this time, not the successful implementation of shadow tactics.

Over time markets will always win out, and with gold, those willing to hang on will be rewarded again. The major problem is for those that got in late and have been taking a beating. That's nothing new in any sector though, so can't be considered unusual with gold.

Unfortunately, those investing other people's money, such as in hedge funds with a lot of exposure to gold, it will take some time to rebound, depending on the price at the various entry points they came in at.

When Will Physical Gold Demand Help Stem ETF Outflows?

The question above is a little disingenuous, because physical gold demand probably won't be the element that reverses the gold ETF outflows.

After all, consider the numbers from the World Gold Council's Gold Demand Trends report. Central bank demand from around the world was over 100 tons in the last quarter; jewelry demand jumped 12 percent; and demand for gold coins and bars were up 10 percent. If that won't push up the price of gold and alter the outlook of investors, something else will be required to do it.

Be aware that the reason central banks around the world are buying up gold is because of their lack of confidence in paper currencies. There is no doubt central banks consider gold a currency. If they didn't they wouldn't be buying it up at such high levels.

As for the amount of gold-backed ETF outflows, it came to 176.9 tons for the quarter.

So the answer to the question of when physical gold demand will reverse the outflows from gold ETFs, the answer may be possibly never. What gold demand does and will continue to do is provide some support for the price of gold during this weak environment.

Having said that, once there is a rebalancing of gold held in ETFs, it is at that time physical demand will be a major factor in the price of gold continuing to rise.

As to the impact of the continual reporting on gold ETF outflows, when its measured against the bigger picture, the story is really much smaller than the media report.

For example, at the end of the reporting quarter, the amount of physical gold held by ETFs was only 1 percent of "the entire 175000t above ground stock of gold," the WGC said.

Futures Markets

Since ETFs only accuont for 1 percent of above-ground gold stocks, the question arises as to why it then would have such an impact on the price movement of gold.

In my view it's more the psychological factor than anything else. The media also report that more than any other factor, causing it to be the major part of the narrative.

For those investors having more of an understanding of the markets, specifically the futures markets, they see the outflows as being more a reflection of the futures markets, which for them is the real culprit behind the price movement of gold.

The outflows and futures markets are connected, with the gold outflows being the more visibly reported element, and the futures markets being the major cause behind it.

Gold Jewelry Demand

It's worth taking a look at the soaring demand for gold jewelry, as the price of gold had taken some wind out of the sales in the industry when it was much higher. That's especially true on the low end of the market in the U.S.

Speaking of the U.S., it had a somewhat surprising part to play in the gold jewelry market, with demand jumping by a huge 22 percent in the quarter, according to the WGC.

China and India continue to play the lead role in gold jewelry demand. Combined the two countries accounted for 62 percent of jewelry demand in the reporting period. When adding the U.S. figures to the total, the three countries generated 84 percent of all jewelry demand for the period.

It's interesting to see gold jewelry demand becoming a significant factor in the price of gold. In the past there was always the temporary seasonal bump when the wedding season in India arrived, but with more disposable income in China, and the price of gold falling, it has become a more important factor than it has in the past. That is likely to continue, offering even further support for the long-term upward price movement of gold.

Jewelry, combined with gold coins, bars and technology demand, "still make up 81 percent of the market."

Institutional Gold Investors

The primary driver of gold ETF outflows has been the response to the drop in the price of gold by institutional investors.

The World Gold Council said the "... reaction may have been driven by several factors; profit-taking on long-held positions; loss limitation on more recently initiated positions; a switch to other investment channels etc."

More than likely all three have played a part in the story.

Another part of the overall picture is that even after the outflow of 176.9 tons from gold ETFs, it only represents 7 percent of the gold held by all ETFs.

While the outlook for gold isn't near as bad as being portrayed in the media, the bottom line is gold-backed ETF exposure risk was what drove the outflows. The reversing of that trend will signal to us the price of gold is heading back up. I'm not sure there will be any more important indicator than that going forward. It's unfortunate, but that's what's driving the price of gold at this time, and if the huge demand for physical gold isn't enough to stop that, it's not likely anything else will either.

Of course it must be taken into consideration that there are circumstances which will reverse the outflows from ETFs. It's not like the outflows will simply happen in a vacuum. What I'm saying is outflows in general seem to be the key metric to watch. More than likely several elements will be part of the reason for the reversal, with the gold-backed ETFs telling us when the effects from them are taking place. The price of gold will likely reverse direction at that time.

Among the catalysts to watch are the strength of the U.S. dollar, inflation, China's economy, Federal Reserve policies, and signs of sustainable weakness in the bull equity market.

George Soros and His Gold Holdings

A headline from CNBC yelled out that George Soros cut his holdings in gold ETFs right before the plunge in the price of gold. That headline is inaccurate as to the reality of Soros' actions.

Soros Fund Management reported in a Securities and Exchange Commission filing that he sold a portion of his stake in the SPDR Gold Trust (NYSEARCA:GLD), bringing the shares held by Soros from 600,000 on December 31 to 530,900 by March 31.

While that's true, Soros also added to his stake in gold by acquiring more shares in Market Vectors Gold Miners ETF (NYSEARCA:GDX), making his stake in it worth more than $100 million.

When it comes to Soros, you've got to watch what he does rather than listen to what he says, as in the past he's used his media platform at times to mask his intentions. After all, if he was that bearish on gold, why would he add to his position in GDX, and why wouldn't he have shed even shares in his gold holdings?

How I see it is Soros recognized the gold ETF outflow trend and repositioned the fund, as it relates to gold, into the undervalued gold mining sector.

Investment Implications

Like the Chinese, one way to invest in gold to protect our assets is by acquiring gold coins. Prices are at levels that make this option an attractive one.

Until we find a bottom for gold, which we are still waiting for, ETFs shorting gold are a good bet. The nature of the collapsing gold price makes them potentially more volatile than usual, but they can also move up very quickly in response to market conditions. All of these should be considered a short-term play.

You must have a high tolerance for risk and the conviction gold prices are going to continue to fall in the near term.

When I mention a short-term play here, we're talking literally one day, as the funds themselves recommend. The longer they are held the higher the risk becomes.

My past practice with these types of funds is to move in and out of them quickly after they make an upward move.

DB Gold Double Short ETN (NYSEARCA:DZZ)

Getting the highest daily volume of the ETFs or ETNs listed here, this ETN attempts to deliver twice (2X or 200%) the inverse return of the daily performance of the DBIQ Optimum Yield Gold Index Excess Return.

What DZZ does is initiate a short position in the gold futures market while keeping a tight bid/ask spread.

Over the last year it has traded in a range of $3.89 to $6.41.

ProShares Ultra Short Gold ETF (NYSEARCA:GLL)

GLL attempts to deliver twice (2X or 200%) the inverse return of the daily performance of gold bullion in U.S. dollars; the price of gold is fixed for delivery in London.

One secondary element for this ETF is it has a higher fee structure, charging 95 bps annually.

It has traded in a range of $55.04 through $92.35 over the last year.


This ETN tracks the performance of the DBIQ Optimum Yield Gold Index Excess Return plus the interest income from U.S. Treasury bills.

It manages over $31 million in assets and has an average 3-month volume of just under 290,000.

DGZ has traded in a range of $11.02 through $14.27 over the last 52 weeks.

VelocityShares 3x Inverse Gold ETN (NASDAQ:DGLD)

What DGLD does is provide three times (300%) short exposure to the daily performance of the S&P GSCI Gold Index Excess Return plus returns from U.S. T-bills.

The bid/ask spread of the ETN is wider because of its low daily volume, and it also charges a hefty 135 bps in fees each year. The company holds net assets of only 5.21 million. Daily volume over the last three months has averaged 95,931.

It has almost doubled since early October, 2012.

For those believing gold is at compelling entry levels, gold ETFs like Market Vectors Gold Miners ETF and Market Vectors Junior Gold Miners ETF (NYSEARCA:GDXJ) are good options. There are many others with different purposes, but these two are good representatives of the overall sector.

Market Vectors Gold Miners ETF

GDX has the purpose of reproducing the price and yield performance of the NYSE Arca Gold Miners Index. It attempts to invest a minimum of 80 percent of its overall assets in gold mining common stocks.

The popular fund has net assets of $7.44 billion, and have daily volume over a 3-month period of over 21 million. It has traded in a range of $26.68 through $55.25 over the last year.

Market Vectors Junior Gold Miners ETF

GDXJ primarily invests in small- or medium-cap publicly traded companies participating in the mining of gold or silver. The desired companies generate a minimum of 50 percent of their revenues from mining. They can also be companies that hold property with that same potential.

With the bottom of gold yet to be proven to be found, of these last two ETFs, GDXJ is the most risky, as many smaller companies will struggle if the price of gold continues to drop, as they have less cash available to defend against it.

Investors could short these ETFs - and others like them - if they believe the price of gold still has significant room to fall.

I've used the gold ETFs in this article instead of gold miners because they're representative of the overall industry. After all, the data here simply confirms the weakness of gold, and that will weigh far more on mining stocks than anything else until the environment talked about in the article changes. You could just about put any gold miner in there and expect similar investment results.

Barrick Gold

There are of course exceptions to the rule as there are in any sector. Barrick Gold (NYSE:ABX), for example, has had just about everything go wrong that could go wrong lately, and that's in one of the worst gold markets in years.

The good news there it is one of the most hated stocks in one of the most hated sectors at this time, which may offer a tremendous opportunity for a good entry point. It has traded in a 52-week range of $17.51 to $43.30. As of this writing it was trading at $19.26.

Many gold miners could be inserted here with similar performance numbers and expectations.


The overwhelming factor influencing the price of gold is gold-backed ETF outflows. Taking into the consideration the catalyst for those outflows is the soaring stock market. The catalyst of the booming market is the Federal Reserve stimulus program. As long as that continues, it is unlikely we'll see a major reversal in the price of gold in the near future.

For the most part, as the World Gold Council report says, physical gold has helped assuage the stimulus effect, but overall, while outflows continue, it won't be enough to stop the hemorrhaging completely.

What will probably happen is the gold ETF outflows will slow, as assertions and rumors the Fed is seriously considering ending its money creation policy could have a detrimental effect on equities.

The Fed isn't going to end stimulus any time soon, but the idea has been planted in the minds of investors, so it adds a little uncertainty to the market.

There is no doubt the underlying fundamentals for gold remain in place. With that in mind, it may be time to look for entry points in gold miners or gold ETFs for long-term gold investors.

Investment vehicles similar to those listed above which short gold are an option if it is believed there is a lot more downside before gold prices reverse.

There is no logic or reason for the plunge in gold and it going out of favor, other than the Fed-induced equity boom. After years of moving up, it was inevitable conditions would arise where gold would have to endure a painful correction. That time has arrived.

That means to me either shorting gold or getting in again for the long term. Those investing in gold with a medium-term outlook are the most vulnerable because the temptation to sell if things go further south could result in the loss of significant capital. It could also lock up capital with unproductive results if the price drops and you don't want to take a loss.

Now it's a question of whether it's a good time to get back into the gold sector or not. Eventually fundamentals will overcome the forces against gold, but there is no guarantee as to how long it will take until that happens.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.