Exchange-traded funds have increasingly become a source of significant asset flows in global markets, and none more so than gold. Billions of dollars change hands every day in the gold market, and gold ETFs now makeup a considerable bulk of those transactions.
In fact, the World Gold Council’s recently released Q3 2013 report on Gold Demand Trends cited ETFs and similar products as the largest single contributor to change in total gold demand. According to the report, gold ETFs accounted for a decrease of 256.4 tonnes of the yellow metal in the third quarter, which brought total demand to 868.5 tonnes. Other factors such as consumer demand, technology use and central bank purchases had very little impact when compared to exchange-traded products.
The benefit of investing in an ETF is that you get instant access to a specific theme with transparency and liquidity that is unmatched by any other source. By purchasing the SPDR Gold Shares ETF (GLD), you don’t have to worry about the hassle of buying, storing, protecting and ultimately selling your gold bullion. However, traditional gold enthusiasts will point out that you can’t exactly walk down the street and exchange your brokerage statement for other goods and services.
Gold has always been viewed as a commodity that has an intrinsic value far surpassing paper currency. It’s considered an inflation hedge against the threat of a falling U.S. dollar and rising costs of living. However, the recent trend of tempered inflation expectations combined with the unprecedented level of central bank monetary policy intervention have held gold prices under water this year.
The report went on to note that “tactical investors in western markets exited their positions as they began to speculate on the early tapering of U.S. quantitative easing amid signs of apparent improvement in the U.S. economy.” The majority of these outflows were absorbed by Asian and Middle Eastern markets, which have continued their healthy thirst for gold bullion. The one exception has been India, which has been trying to curb its gold imports through the use of trade restrictions and excessive duties.
According to Index Universe, the GLD ETF alone has seen outflows of more than $22 billion in total assets since the beginning of the year. This trend has been mirrored in other gold bullion and gold miner funds as well. GLD has now lost more than 24% of its value in 2013 and has been meandering sideways since it bottomed in late June. That’s a stunning contrast to the double-digit positive return we’ve had with almost every major stock index fund.
Value-seeking investors who don’t mind a little volatility might want to consider an allocation to GLD as a way to diversify their portfolio with a non-correlated asset class. GLD certainly represents a low-risk entry point with a defined exit point at the prior lows using a stop loss or sell discipline to guard against further declines. With stocks on their highs, it may be an alternative way to add a defensive position to your portfolio.
More aggressive investors can consider a trade in gold mining stocks such as the MarketVectors Gold Miners ETF (GDX), which have fallen further this year but may bounce back stronger. The chart patterns are relatively similar and offer a similar natural exit point to protect against downside risk.
No matter how you play the precious metal sector, remember to start small and leg into positions slowly. That way you can use time and price to your advantage in order to increase or decrease your allocation size according to your risk tolerance. Right now this is definitely a contrarian play that may take time to develop, but it could have excellent long-term potential.
David Fabian is Managing Partner and Chief Operations Officer of FMD Capital Management. As of this writing, he did not hold a position in any of the aforementioned securities. Learn More: Why I love ETFs, And You Should Too.