Tags: gold | ETF | paper | physical

Paper Gold’s Influence on Physical Gold

Monday, 29 Apr 2013 07:43 AM

By Sean Hyman

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Before the last decade, if you wanted to invest in gold, you’d either trade gold futures (which is what the speculator would do) or you’d invest in gold coins or gold bars.

However, over the past 10 years, we’ve seen the advent of the gold exchange-traded fund (ETF), with one of the most common being the SPDR Gold Shares (GLD).

This became a new way for investors to either buy a product that either tracked gold or in some cases was actually physically backed by gold.

It brought in a new crowd of traders and investors. Was this good or bad? Well, it certainly had its pros and cons. Let’s take a look at a few of them.

Of course the pros were that a stock trader or investor could now trade or invest in gold right through their stock brokerage account without having to have a futures account and without the need to be well-versed in futures contracts, expiries, etc.

It also brought in more buying overall to gold because stock investors who were hesitant before now were “getting into the game.”

GLD started up when gold was trading in the $400s per ounce back in late-2004. I believe it and other gold ETFs were partially responsible for how quickly gold reached $1,900 an ounce. Had it not been for the advent of these ETFs, I believe it would have taken gold longer to reach these heights.

However, there are cons to gold ETFs too, as far as how it affects gold’s price.

For instance, the guys that traded gold futures were savvier when it came to gold than the equity crowd that bought gold was. So this caused quite a bit more volatility, as the equity crowd was much less sure of themselves when it came to investing in gold.

Additionally, those who bought gold coins and gold bars were really savvy and very long-term investors. This gave gold much more stability and less volatility before.

Another con is that gold ETFs got so popular that they were holding as much gold in their reserve holdings as some smaller countries’ central banks would be holding.

Even after a huge correction recently, GLD still has over $50 billion in gold or over 34 million ounces of gold held. That’s huge!

So there are still quite a lot of novice gold investors still in the gold game. That means there will continue to be more volatility for now.

Additionally, while these ETF investors were a large part of the quick run-up, they’re also a huge reason for gold’s recent breakdown in price too.

How do we know? Physical gold is still in huge demand. The U.S. mint just ran out of its smallest American Eagle gold coins due to such high demand. In March alone, the mint sold over 196,000 ounces of gold to investors. So the physical demand is still there. And it should be.

Why? Central banks are still printing money and still driving down the value of their paper currencies. Additionally, the global economy is still not on solid ground, even though it’s better than it was just a year or two ago.

But just because there is a currency war going on with major central banks driving down their currencies, that alone is enough reason to own gold (hard currency that can’t be printed).

However, due to the retail equity investor still being so involved in the gold market, I believe they’ll continue to be more easily “spooked” for a bit longer. I expect another good sell-off to be just around the corner in gold.

But once more “weak hands” get shaken out of gold, and I believe gold will continue to rise overall in light of the aggressive environment that we’re in with some of the world’s largest central banks.

Additionally, many gold miners need gold to be higher in order to continue to break even and meet their production costs. Should these not be met for a period of time, they’d slow down or halt production until the supply got low enough that the continued demand drove the price back up enough to where they could profitably dig it out of the ground once again.

So the bottom line is paper gold has paved the way for more volatility and more downside selling in the near term. However, ultimately, gold will end up going higher once enough gold ETF investors have been scared out of their gourd and exit their positions.

About the Author: Sean Hyman
Sean Hyman is a member of the Moneynews Financial Brain Trust. Click Here to read more of his articles. He is also the editor of Ultimate Wealth Report. Discover more by Clicking Here Now.

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