A couple of weeks ago the gold exchanged-traded funds industry celebrated its 10th anniversary. When an Australian founded that sector a decade ago it is unlikely he foresaw the role it would play in the surge on gold to record levels, and its subsequent precipitous fall.
Until March 2003, when Gold Bullion Securities was listed on the Australian and London exchanges, there were no gold ETFs. At their recent peak, however, the gold ETFs were holding, or at least were exposed to, more than $US150 billion of gold.
Gold ETFs were the brainchild of an Australian, Graham Tuckwell, whose ETF Securities pioneered the development of commodity ETFs and which developed Gold Bullion Securities in partnership with the World Gold Council. It is doubtful they ever contemplated how significant the gold ETF sector would become.
From a standing start a decade ago the gold ETFs’ holdings of the metal grew dramatically and were still growing even after the gold price peaked in 2011. Late last year they reached about 85 million ounces – and then the sell-off began.
In the past six months the ETFs have experienced outflows of about $US10 billion as part of a general exodus of investors from commodity ETFs. Last week alone, according to Bloomberg, the outflows from gold and precious metal funds were about $US1.26 billion.
There are, of course, fundamental reasons for the decline in the gold price. As my colleague, Alan Kohler, wrote this morning the market appears to have been overly excited about the threat of inflation in the wake of the financial crisis and the massive amounts of money-printing it ignited. With the fears about the extent of that inflation threat receding, the price has tanked.
Nevertheless, the role that the ETFs have played in both the run-up in the price and the recent sharp decline is worthy of note.
Before Tuckwell created the first of the gold ETFs 10 years ago the ability of investors to easily trade the metal was constrained by the need to store and insure the physical metal and, for some, the complexity of hedging currency risk.
The ETFs – and there is an array of different types of funds offering exposures that range from vanilla physical exposures, through to leveraged funds and more exotic derivative exposures – gave investors, including retail investors, a relatively low-cost way to get a direct exposure to the gold price.
It also created much deeper liquidity in the market for gold, among other commodities – it became far easier to trade in and out of the market – which may be part of the explanation for why gold overshot on the way up and why it has fallen so precipitously on the way down.
It is their potential impact on the volatility of commodity markets that has caused regulators to scrutinise ETFs, particularly the more exotic ones, closely.
They have been concerned about the potential for systemic risks within them as well as the way they have transformed markets that were once dominated by participants in real economic activity into markets now dominated by financial investors and speculators.
The gold market, of course, has always been influenced by investor activity. Now, thanks to Tuckwell, there are just a lot, lot more of them.