Gold investment apathy

The latest covered Q3’21, where gold slumped a slight 0.8%. But that masks some large intra-quarter selloffs that were part of a broader 9.6% gold correction. Overall global gold demand proved weaker last quarter, falling 7.1% year-over-year to 830.8 metric tons. Investment demand was the sole culprit, plummeting 52.5% YoY to 235.0t! Yet traditional physical bar-and-coin demand stayed strong, surging 18.4% YoY.

Gold exchange-traded funds have overwhelmingly become this metal’s investment-capital-flows wildcard, the tail wagging the gold-price dog. They collapsed from a massive 273.9t build in Q3’20 to a 26.7t draw in Q3’21, an enormous 300.6t swing! That dwarfed last quarter’s mere 63.7t retreat in overall global gold demand. Gold-ETF capital flows have often proven gold’s dominant driver for lots of quarters over many years.

And two American behemoths command the lion’s share of the capital deployed in gold ETFs worldwide, the GLD SPDR Gold Shares and IAU iShares Gold Trust. The WGC tracks global physically-backed gold ETFs in its quarterly GDT reports. As of the end of Q3’21, GLD’s and IAU’s bullion holdings represented 27.6% and 13.9% of all the world’s gold ETFs’! Their collective 41.4% compares to a distant third place’s 6.7%.

Of that negative 300.6t swing in gold-ETF holdings comparing Q3’21 with Q3’20, GLD and IAU alone accounted for 214.8t or 71.5%! That’s not unusual, as GLD+IAU-holdings swings have weighed in at nearly all or even more than the entire global-gold-ETF space in plenty of recent quarters. Gold price trends are overwhelmingly driven by investment demand dominated by gold ETFs, and GLD+IAU are the biggest.

Instead of quarterly like the WGC’s data, GLD and IAU report their physical-gold-bullion holdings daily. That makes them the best high-resolution proxy for global gold investment demand. And that has proven weak since mid-June, when an unexpected catalyst prematurely killed a young gold upleg. After gold had just powered 13.5% higher in 2.8 months, mid-June’s FOMC meeting ignited huge gold-futures selling.

The Fed didn’t even do anything that day, maintaining its colossal $120b of monthly quantitative-easing money printing indefinitely with no hints of tapering. But top Fed officials’ unofficial individual federal-funds-rate outlooks in the accompanying dot plot proved hawkish. Merely 6 out of 18 of those guys saw maybe two quarter-point rate hikes way out into year-end 2023. That may as well be an eternity away in market time.

The US Dollar Index shot higher on that, unleashing panic among gold-futures speculators. Running with hyper-leveraged bets, they can’t afford to be wrong for long. Gold plummeted 5.2% in just three trading days on these traders puking out huge amounts of long contracts. That mid-summer shock first soured investors’ gold psychology, and it hasn’t recovered since. That resulting apathy drove gold’s sideways grind.

This chart superimposes GLD+IAU holdings over gold prices during the last several years. Major gold uplegs and corrections are tagged, along with the GLD+IAU builds or draws in those spans. Ever since that mid-summer FOMC dot plot derailed that young gold upleg, investors have been missing in action. They are indifferent to gold until it exhibits sufficient upside momentum to attract them, which hasn’t happened.

Gold price trends are highly correlated with gold-ETF capital flows, particularly GLD+IAU holdings. Prior to this latest Fed-truncated upleg squib, gold’s previous two uplegs both maturing in 2020 were massive. Gold powered 42.7% and 40.0% higher on enormous GLD+IAU builds of 314.2t and 460.5t! Strong gold-ETF buying fuels major gold uplegs. The basic mechanics of physically-backed gold ETFs explain why.

Their mission is to mirror the gold price, but the supply and demand for gold-ETF shares is independent from the gold-futures trading driving gold’s global reference price. So differential buying or selling of GLD and IAU shares relative to gold will soon cause their prices to decouple from the metal’s that they need to track. These gold ETFs’ managers avert these failures by issuing new or buying back gold-ETF shares.

When GLD and IAU share prices are being bid higher faster than gold, their managers have to sell shares to offset that excess demand. They use the proceeds to buy more physical gold bullion. So rising GLD+IAU holdings, which are called builds, reveal stock-market capital flowing into gold. These monster gold ETFs are effectively conduits for the vast pools of American stock-market capital to slosh into and out of gold.

Conversely when GLD and IAU shares are being sold faster than gold, their prices will soon disconnect from gold’s to the downside. ETF managers have to absorb that excess supply by buying back their own shares. They raise the necessary funds by liquidating some of their physical-gold-bullion holdings. So falling GLD+IAU holdings or draws show stock capital shifting back out of gold, which we’ve seen since June.

Gold-ETF capital flows tend to lag gold upleg-and-correction cycles, because investors are momentum players. They aren’t interested in buying anything including gold until after it has been rallying persistently and considerably for some time. So even though gold’s last correction after mid-2020’s massive upleg bottomed in early March 2021, GLD+IAU holdings didn’t hit their own trough of 1,512.8t until late April.

But with gold decisively powering higher again, the investors started returning to chase that momentum. By mid-June shortly after that fateful FOMC dot plot, GLD+IAU holdings had climbed a modest 2.9% or 44.0t. But gold’s distant-future-rate-hikes-scare plunge, and several subsequent bouts of heavy-to-extreme gold-futures selling, shattered investors’ nascent bullishness. They’ve been gradually fleeing since.

While the GLD+IAU draws since mid-June have been fairly-mild, they’ve proven relentless. Gold itself bottomed in late September after a 9.6% correction fueled by that outsized gold-futures dumping. Yet GLD+IAU holdings kept grinding lower into early November, clocking in at a substantial 5.5% or 85.7t total draw. With investment capital migrating out of gold, even big gold-futures buying couldn’t spark an upleg.

Major gold uplegs like last year’s are three-stage affairs. Their initial sharp gains out of deep lows are fueled by speculators buying to cover profitable gold-futures short contracts. The resulting gold surges soon attract in other gold-futures specs on the long side. But despite their big influence over short-term gold prices due to the huge leverage inherent in gold futures, these traders’ capital firepower is very finite.

That stage-one short covering and stage-two long buying can only run for a couple-few months before it exhausts itself. That needs to drive gold high enough for long enough to convince investors to return. Their vastly-larger stage-three buying can run for many months or even years, ultimately catapulting gold way higher. Fleeting gold-futures buying acts like the necessary trigger to spin up sustained investment buying.

That gold-bullish flywheel dynamic almost spun back to life in November. Enormous spec gold-futures long buying drove gold a sharp 8.2% higher between late September to mid-November. That started to break though investors’ festering apathy, leading to the biggest GLD+IAU holdings build since May when gold was surging. But unfortunately the necessary gold-buying handoff from speculators to investors failed.

The baton was dropped when specs’ gold-futures long buying exhausted itself before enough investors started migrating back into gold. The primary trigger failed to ignite way-larger secondary buying in time. Speculators’ upside bets on gold were so overextended that another bout of heavy gold-futures selling erupted, the fourth since mid-June. Investors were demoralized enough to stop differentially-buying gold-ETF shares.

Gold has spent the past-half year grinding sideways on balance because apathetic investors are missing in action. Note in this chart that gold’s 200-day moving average, which illuminates its short-term trend, is closely following GLD+IAU holdings lower. The next gold upleg again depends on gold-futures buying forcing gold high enough for long enough to convince investors to return. That is probably coming soon.

Several major gold-bullish catalysts are coalescing around a common linchpin of raging inflation. As this comes to a head, investors’ vexing gold apathy will be shattered. Facing a situation never before seen in market history, they will likely flock back to gold with a vengeance. This leading alternative asset is an essential portfolio diversifier, tending to rally when stock markets swoon. It is also the ultimate inflation hedge.

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