It’s hard to believe that a mere 7 years ago physical gold ETFs didn’t exist. The launch of the SPDR Gold Trust ETF (NYSE:GLD) in 2006, though, proved that there was a market for a simple, paper-based way to invest in gold bullion. The Gold Trust’s success spawned a mass of imitators, and now physical gold ETFs hold 2,100 tons of the metal in vaults around the world, according to The Globe and Mail.

Physical gold ETFs are particularly popular with hedge funds. Take John Paulson’s New York-based Paulson and Co. hedge fund, for example. As the single largest shareholder in GLD, Paulson’s fund holds some $4.3 billion in gold via the ETF. That’s good for 8 percent of GLD’s total value.

With so much capital tied up in physical gold ETFs, what happens when Paulson and other hedge fund managers decide they’re ready to unwind their positions? It’s the ultimate question, and it’s one that will likely lead to a lot of profits and a whole lot of losses (for people on the wrong side of the trade) in the future.

Some investors argue that gold ETFs have driven up prices for gold artificially fast by lowering the barrier to entry. As the share price in gold ETFs climb, those ETFs are forced to accumulate more physical gold bullion. That in turn puts upward price pressure on gold spot prices, which in turn leads more people to invest in gold ETFs, etc. That cycle leads to what some investors refer to as an echo chamber or a self-fulfilling prophecy on gold prices.

When sentiment turns against gold, then, the results could be ugly. Just as physical ETFs make it easy to invest in the yellow metal, it also makes it easy to sell. If enough gold investors dump their shares in GLD and other physical gold ETFs at the same time, spot prices for the metal could plummet with the fresh glut of supply. That in turn could lead more people to sell off their shares in GLD and related ETFs.

Not everyone’s convinced the effects of GLD are that powerful, though. David Franklin, an analyst at Canada’s Sprott Asset Management, tells The Globe that money flowing into ETFs has likely just come at the expense of investing in gold mining stocks. Juan Carlos Artigas, an investment manager with the World Gold Council, points out that ETFs account for just 8 percent of global gold demand. Contrast that with jewelery demand, Artigas says, which holds a 50 percent share and coin demand, which drives about 25 percent of gold demand.

Both are valid points that seem to indicate ETFs aren’t manipulating markets as much as people might think. I buy the arguments for the most part, but recognize that they’re just theories. There hasn’t been a major downturn in gold prices since 2006 (when GLD was launched), and that means we haven’t seen the full destructive force of a bearish swing against GLD and other gold ETFs.

I imagine if John Paulson sold off a large stake in GLD, a lot of investors would follow suit, and the results wouldn’t be pretty. Sure, the hedge funds will have nice returns, but the man on the street might end up sitting on a collection of gold that’s worth a fraction of what he paid. I don’t see that happening anytime soon, but when it does, I hope to stay well clear of the carnage.

Related

Tags: GLD, gold price, gold supply, John Paulson

gold, gold stocks, mining stocks, precious metals, stock tips | RSS 2.0 | Respond | Trackback |

Notice: ALL information on TradingStocks.me is for informational use only and should never be construed as investment advice. TradingStocks.me and all affiliated companies SHALL NOT be liable for any damages whatsoever arising out of or related to the websites or the information contained in it.