I have written extensively about the extremely strong relationship (.pdf) between gold ETF holdings and gold prices. For much of this year, that relationship benefitted gold, as both holdings and prices relentlessly increased. The trend has obviously reversed over the past month, but interestingly, prices led the decline in holdings.
It is important to remember that gold investors are not a homogenous group. There are gold bugs— perennial bulls who most likely hold physical gold rather than shares in ETFs, there are momentum traders who sell on the first sign of weakness, and then there is everyone in-between. One of the most significant differences between these groups is their respective levels of conviction. Gold bugs will never sell. Momentum traders will sell in a heartbeat. Importantly, the liquidity of gold ETFs makes them a very appropriate vehicle for those closer to the momentum trader side of the spectrum of conviction. Without a doubt, many of these traders bought gold ETFs simply because prices were rising. As prices fall, the process works in reverse.
Since last Monday, gold ETF holdings have fallen nearly 1 million troy ounces, or 31 metric tons. Even so, at a current level of 65.8 million troy ounces, holdings are still up nearly 7.5 million troy ounces since the beginning of the year. With risk appetite in the broad financial markets returning and Euro-area sovereign debt concerns almost completely off the radar, there is little to encourage gold investors to buy aggressively. Indeed, as such investors already hold near-record amounts of the metal, there exists enormous risk to the price of gold in the event further liquidation occurs.
I like gold; it has a place in every portfolio (if only to hedge against Armageddon), but my suggestion is to wait for a more attractive entry point to buy.
Disclosure: No positions