Why Is The SPDR Gold Trust In A Free Fall?

Ed Liston

The gold ETF with the largest asset under management is the SPDR Gold Trust (GLD). If you see a GLD chart for the last 6 months, you will see that the ETF is falling down a cliff. Although this is tied in to the free fall of gold itself in recent months, this article is going to focus on the GLD ETF itself, as well as broader movements in gold’s price that is influencing GLD.

Gold is a hot topic of discussion in the global financial market. It is one of those commodities which has no full-proof fair value calculation methodology. Investors invest in gold to hedge against inflation, to protect themselves from an economic downturn and to diversify their portfolios. The gold market therefore follows an entirely different trend as compared to the other financial assets market.

GLD reflects the performance of the price of gold bullion, less the trust’s expenses. It controls more gold than most countries’ central banks. Currently, the total asset under management for the trust is more than $51 billion according to the closing price of 15th April. The number of shares outstanding is more than 383 million. The comparative bar graph between SPDR gold share return and physical gold return over the years is given below.

As expected, the returns of both SPDR gold share and physical gold are strongly correlated. A small difference is due to the expense ratio of 0.40% that the trust charges from its investors. Though the returns in the last one year has been negative, GLD has given 12.28% and 10.91% returns over the last three and five years respectively. Since its inception in November, 2004, the return has been 16.14 %.

Is GLD really as good as gold?

GLD is a gold denominated debt security created for the specific purpose of enabling gold investment through it. These investments are backed by the gold assets. Some of the advantages to invest in GLD are-

  1. It tracks the physical gold prices approximately.
  2. It is a convenient way to trade on gold prices.
  3. It provides diversification benefits for an investor’s portfolio.
  4. Since it trades like a share, its market is quite liquid, which ensures efficient price.
  5. Because of no physical custody of gold, there are no storage and insurance expenses for the investor.
  6. Expensing ratio is much lower than the overall cost of owning physical gold.

GLD has helped in creating an efficient gold trading market. It has solved the storage, logistics, transportation and insurance issues with the physical gold that previously hindered the development of the efficient market.

But the question of whether GLD is as good as your own physical gold still exists. The trust managing GLD claims that the gold bars are held in HSBC’s vault in London and shares are sold in baskets of one unit. Regular investors have no rights of redemption. The gold is not required to be insured by the Trust, and therefore is not liable for loss, damage, theft, or fraud. Shares are bought in the open market, only after authorized participants decide to place or sell them. Therefore a retail investor doesn’t actually “own” gold, but an asset that is backed by gold and represents a certain quantity of the yellow metal. There are doubts over the trust’s management of its physical gold, with questions over how much is actually held.

Gold ETFs have expanded the market base and the overall market, but they still represent less than 10% of the total demand of gold. Owning GLD is clearly not the same as owning physical gold, it just serves different purposes.

GLD in the last four years and its recent free fall

GLD has been experiencing a downward pressure in the last few months. This downward trend was observed after approximately four years of bull run. The chart below shows the GLD price movement over the last five years, along with its 100-days and 200-days moving average trend.

(Click to enlarge)

As it is evident from the graph, GLD has been on an upward trend since December 2008. It has been continuously trading above its 100-days and 200-days moving averages. This was initiated because of the sub-prime crisis that later led to the economic meltdown in the U.S. The eurozone debt crisis has also been one of the reasons for the investors putting their money on gold. This substantiates the popular belief about the positive impact of an economic downturn on the gold prices.

The chart below compares GLD to S&P 500 index.
(Click to enlarge)

It clearly indicates that the movement of GLD and S&P index has been negatively correlated to each other in most parts of the period. This is consistent with the common belief that gold is a safe haven in a downturn. Whenever the risk in equity investment is high, people prefer to invest in a supposedly safer asset – gold. This leads to an increase in demand of gold and therefore an increase in its price.

The chart below shows the GLD price movement over the last two years, along with its 100-days and 200-days moving average trend.
(Click to enlarge)

As it is evident from the graph, GLD has been quite volatile over the last two years. It has been facing resistance around the level of $175 since the last few months. The support level during this period was around the level of $150. It crossed this support level just a few days back because of the massive gold sell-off, which caused a sudden fall in its price. It is currently trading at around $132.

One of the possible reasons behind this flattening of gold price over the last one year is a better global economic growth forecast, especially in the U.S. This has lifted the interest rate increase expectations and the investors are now ready to invest in a more risky asset than gold. Because of the political-economic uncertainty in the U.S. recently, people are buying more Treauries, which led to some weakening of dollar and therefore resulted in more downward movement in the gold price.

Recently, the share price of GLD experienced a free fall, consistent with a drop in the physical gold price. GLD shares plummeted from around $151 to $131 in just two trading days. This led to an elimination of more than $7 billion in the assets under management. This was the biggest one-day percentage drop in the gold prices since February 1983 that resulted in a loss of more than $1 trillion for the total stock of gold bullion around the world.

(Click to enlarge)

Reasons for the recent price fall

Some of the reasons that might have triggered the recent free-fall in the gold price, and therefore the gold ETF are-

  1. There were indications that some members of Fed favored earlier exit from quantitative easing (QE) than previously assumed. This development gave a signal to the investors that though the U.S. economy might not have recovered completely from its economic crisis, but at least the decline phase is over.
  2. There have been overall weakness in the commodity market this year, and low interest rates appear to have boosted the investment in other assets such as equity and bonds.
  3. There were reports that Cyprus will have to sell its gold reserves in order to pay-off its debt. This might have spread panic among the investors regarding the possible increase in gold supply. Also some people believed that even the advance economies of Europe will have to sell their gold reserves in order to get out of the debt burden.
  4. Another reason has been the huge outflow from gold ETFs, including GLD, which experienced their largest monthly outflow in February. GLD also saw net outflows of around $5.4 billion year-to-date. This made the ETF trusts to sell their physical gold holdings, which contributed to the fall in its price.
  5. Gold prices have been breaking the technical support levels over the last few weeks. This might have led the investors to interpret it as a possible future bear run.
  6. China recently announced its annual GDP growth ratio of 7.7%, against a median forecast of 8%. Bullion markets, which were already clinging on the support levels, reacted in panic, further leading to price fall.
  7. India, the world’s largest gold importer, increased the tax on gold imports two times this year, due to widening current account worries. This increase in taxes is expected to reduce the gold imports from $58 billion in the last fiscal year to $38 billion this year. Though not a big factor, but this might have been holding the stock to move up in the last two months.

Did GLD contribute to the gold price fall?

Though it is difficult to quantify how much has GLD contributed to the recent gold price fall, it has certainly played its part. These prices are generally controlled by the supply and demand of the physical gold, but that is when the market is performing efficiently. During the time of the free fall, there are some other factors as well. As GLD holds more gold than most countries’ central banks, any volatility in its price surely reflects on the market sentiments. Traders can sell GLD just as easily as they can buy them. This convenience provided by GLD could have contributed to more volatile prices.

The graph below compares the gold price to gold demand over the years. Normally a rise in price should be a result of a rise in demand. But that is not the case here. Q1 2011 gold demand was the lowest since 2009, still the gold price rose.

Now the next graph compares the holdings in gold ETFs to the price of gold. It also separately illustrates the share of GLD in this ETF market. There certainly seems to be a positive correlation in ETF holdings and the prices.

One can argue that with rise in prices, people would want to invest more in gold ETFs, which would give these ETFs more money to invest on gold. Therefore it’s not really clear whether ETF holdings increase was a cause or an effect of rising gold prices. But they certainly seem to be correlated.

What next?

This price fall has led to a panic among investors. Most investors sold off their gold and gold ETFs like GLD for preventing short term losses, rather than focusing on long term. The fall was more prominent because of the significant selling by the major players in the market. With a majority of gold futures and ETF investors using leverage to trade, the steep decline led to margin calls. This further created panic and thus more selling. But there are some factors that still signal the possibility of a turnaround in the current trend.

The basic factor of economic slowdown, driving the gold prices for decades still exists in the current scenario. The U.S. economy is still going through a phase of low headline inflation and is far from its recovery from the slowdown. The role of gold as a traditional protection against inflation cannot be destroyed by bad economic news. The eurozone hasn’t recovered yet from its debt crisis and is expected to take a few more years.

Not only this, the demand of gold is also not expected to fall drastically. On the contrary, it will increase as a result of low price right now. In Asian markets like India, people actually prefer to own gold, rather than to trade it electronically. With this sudden drop in the prices, the demand for gold is expected to rise from India. This is because people in India perceive gold as a long term traditional asset, and therefore would be happy to be able to buy gold at a much cheaper rate than they could a week back. Demand from China is also expected to rise, despite slower than expected GDP growth this year. According to the World Gold Council, India and China together account for more than a third of global gold demand. Therefore this should provide a support to the gold price and not let it plunge to an unrecoverable level.

Therefore this might be taken as another opportunity by investors to buy at low prices (with a maximum exposure of 2-2.5% in the portfolio), rather than selling their existing gold investments at loss. It can’t be predicted where the price fall will get its support in the short term. Low price might be an opportunity to invest in gold again for the long term, though the entry point depends on the price movement over the next few weeks.


About abwehra group

The Art&Science of Trading Gold
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