Shorting in futures market the likely culprit behind rout
Exchange traded funds are listed investments whose unit price mirrors or tracks the price of sharemarkets, sharemarket sectors, bonds and commodities, including precious metals like gold. Investors and traders have taken to ETFs in a big way. There is about $US2 trillion ($1.9 trillion) invested in ETFs around the world, from about half that three years ago.
However, that growth includes higher share prices and higher gold prices over that time, as well as the flow of money into ETFs. Before ETFs, Australian investors wanting to invest in physical gold would most likely have to own gold stored at the Perth Mint. Most gold ETFs are backed by physical gold. But there have been concerns about ETFs available overseas that use derivatives to track the gold price rather than being backed by physical gold.
Most experts say if there is a culprit for the massive sell-off in gold, it is more likely to be the futures market. Greg Canavan, the editor of Sound Money. Sound Investments, says: "What's happening is that the paper market [futures] is huge and that is where the price [of gold] is set."
Hedge funds buy the paper and they short gold futures as well, he says. "Shorting" is a way of making money on an investment if the price of the investment falls. There is much more trading of "paper" gold in futures markets than in physical gold, Canavan says.
"[Traders] make big bets and if the bets go wrong there is a massive unwinding of positions as these futures contracts always involve leverage, where movements in prices are magnified," he says. Canavan does not think that ETFs are to blame. It is the units in the ETFs that are sold and not the physical gold. It is not adding to the supply of gold as people sell their ETFs.
ETFs have increased the liquidity of gold, says Shane Oliver, the chief economist at AMP Capital Investors. "With that comes volatility," he says. "But you would not blame ETFs for the sell-off in gold."
However, while there are fundamental forces driving the direction of the gold price, ETFs can help speed-up the trend in the gold price. The hope of the gold "bugs", those who love the precious metal, was that "quantitative easing", the printing of money in the US and Europe, would generate higher inflation and a weaker US dollar and the gold price would keep rising. But inflation has not appeared and the US dollar has not weakened. Investors want out of gold, Oliver says.
For Australian investors, two gold ETFs are listed on the Australian sharemarket. They are backed by physical gold held in London and do not use leverage. BetaShares' Gold Bullion ETF tracks the US dollar gold price. The other gold ETF, Gold Bullion Securities, is technically not an ETF. It is an "exchange-traded commodity". The gold security is not hedged for currency exchange-rate risk and tracks 10 per cent of the Australian dollar price of gold.
Frequently Asked Questions about this Article…
Most experts quoted in the article point to the futures (or “paper”) market as the likeliest culprit. Hedge funds and other speculators shorted gold futures and, when big bets went wrong, leveraged positions were unwound, magnifying the fall. Commentators say ETFs increased liquidity and can speed trends, but they are not seen as the primary cause.
"Paper" gold refers to instruments such as futures contracts and derivatives that track gold prices but don't necessarily involve the metal itself. Physical gold is the actual bullion stored (for example, historically at the Perth Mint for many Australian investors). Futures markets involve a lot more trading volume and leverage, which can amplify price moves compared with holding physical metal.
According to the article, ETFs are not to blame for the sell-off. ETFs have increased liquidity in the market and can accelerate price moves, but selling ETF units does not directly add to the physical supply of gold. The bigger risks for dramatic price moves are in leveraged paper markets and futures trading.
Shorting gold futures means betting that the gold price will fall. Traders can use leverage in futures markets so price moves are magnified. If many traders short and then have to unwind those positions quickly, it can create a sharp, rapid move in the gold price that affects ETF values and any investor with exposure to gold.
The article says most gold ETFs are backed by physical gold. It notes concerns exist about some overseas ETFs that use derivatives to track gold rather than holding bullion, so investors should check how any ETF they consider is structured.
Two products mentioned are BetaShares' Gold Bullion ETF, which tracks the US dollar gold price and is backed by physical gold held in London, and Gold Bullion Securities, which the article describes as an "exchange-traded commodity" rather than a technical ETF. Gold Bullion Securities is not hedged for currency exchange-rate risk and, as stated in the article, tracks 10 per cent of the Australian dollar price of gold.
Yes. The article quotes AMP Capital economist Shane Oliver saying ETFs have increased gold market liquidity, and with that increased liquidity comes volatility. ETFs can therefore help speed an existing trend in the gold price.
The article suggests investors should check whether an ETF is backed by physical gold vs derivatives, where the bullion is held, whether the product is currency‑hedged, and whether the product uses leverage. Understanding these features helps investors know how a product will behave during sharp moves caused by futures market activity.
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