FxWirePro: A Run Through Gold ETFs amid Global Uncertainty

Gold ETFs retracement to previous highs could potentially boost the gold price by around $100/oz. In the sixteen years since the launch of the first gold exchange-traded product, gold ETFs have transformed the gold investment market. They have reduced the cost of ownership, increased efficiencies and provided added liquidity and access. It is a well-established investment vehicle with 110 gold ETFs available presently. Collectively, as of July 31st, 2019 they held about 2,600 tonnes of gold, worth a value of $120 billion (refer above chart). With assets under management at this level, total gold ETFs now rival some major central banks in holdings, falling just behind the US, Germany and the IMF but ahead of Italy and France. Presently, gold-backed exchange-traded products are also well-diversified regionally. While the US and Europe account for the lion’s share of assets under management, ETFs in Asia have grown, too. 

How saturated is the market? Currently, global ETF gold holdings are only 240 tonnes shy of their all-time peak marked in December 2012. Relative to the peak, a majority of the volumes were lost by North American- listed funds, which have shed almost 460 tonnes from their highs which could theoretically be recaptured. European funds have grown consistently since early 2016 and currently account for 46% of the total global holdings, but clearly have more space for growth if another crisis strikes the region. Similarly, Asia-listed products have the capacity to expand further. 

A single variable regression between the monthly changes of global ETF holdings and gold price over the last five years indicate that gold prices would likely increase by about $42/oz for every 100 tonnes increase in global ETF holdings. Essentially, this implies that were the global ETFs to recapture the 240 tonnes lost since the end of the European debt crisis, gold price could reset about another $100/oz higher. 

However, due to the high base effect, we don't believe global ETF holdings have the capacity to increase anywhere close to approximating the rapid growth over the first eight years after inception. This essentially caps both the volumes and the associated price appreciation. 

Gold price hasn’t moved anywhere from its open price of $1,538, currently trading at $1,539 levels. Despite the recent rally, we do not yet think a recession is fully discounted in the gold price and we now see gold prices peaking at around $1,780/oz by year-end 2020 and averaging $1,418/oz in 2019 and $1,724/oz in 2020.

At the same time, we do not view the current bullish setup for gold as the onset of another decades-long Golden Era, as was experienced in the first decade of this century.

Well, contemplating all the above technical rationale, on trading grounds, at spot reference: $1,538 levels, one can think of call options spread with upper strikes of $1,550.27 levels.

Alternatively, on hedging grounds, we advocated long positions in CME gold contracts of September delivery. We now like to uphold the same strategy by rolling over the contracts for September’19 delivery as we could foresee more upside risks amid the global financial crisis. Courtesy: JPM