ETFs Stoke Investors' Gold Fever - WSJ.com

ETFs Stoke Investors' Gold Fever - WSJ.com

ETFs Stoke Investors' Gold Fever

New Way to Trade Adds
Luster to Fabled Metal;
Jewelry Demand Drops

By PETER A. MCKAY and DIYA GULLAPALLI
January 5, 2008; Page B1

Gold's place in the financial system dates back centuries, but it is enjoying a modern-day renaissance, thanks in part to new vehicles that allow investors to buy and sell the precious metal as easily as a share of Google stock.

The price of gold fell $3.30, or 0.4%, to $863.10 a troy ounce on the New York Mercantile Exchange's Comex division Friday, but that was after hitting a 28-year high earlier in the week. It is now up 43% from a year ago. Investors have been flocking to it as the outlook for more-conventional investments like stocks and bonds becomes cloudier.

Analysts point to the introduction of exchange-traded funds linked to gold as a potent new catalyst for interest in the yellow metal. ETFs trade on exchanges like stocks, but their performance can be tied to almost anything, from the value of commodities to the performance of stock indexes like the S&P 500 index or the Dow Jones Industrial Average.

The most-active gold ETF -- called streetTracks Gold Shares, trading under the ticker GLD -- now averages about eight million shares a day in turnover, more even than Google Inc.'s shares, which change hands less than seven million times a day on average. GLD's underlying holdings of the precious metal are greater than the European Central Bank's or China's central bank.

Demand from investors is driving the price of gold higher, even though demand for the metal for things like jewelry is surprisingly soft.

"The single most important thing to understand about the gold price is that it's being driven higher by investment," says Jeffrey Christian, managing director of CPM Group, a commodity-focused financial-services firm in New York. "That investment demand has been pretty broad-based around the world, and it doesn't look like it's close to ending."

PODCAST

Markets & Investing¹: Peter McKay talks with Jeff Christian, of CPM Group in New York, about why gold is rallying and its role as a haven for investors worried about the U.S. economy's direction.

Since early 2003, at least eight gold-related ETFs have been listed world-wide. Similar ETF offerings have also cropped up for metals such as silver and platinum.

Most of these offerings require that each ETF share purchased by investors be backed up by actual metal held in a trust by the ETF issuer, usually a bank or other financial firm.

The biggest is the streetTracks Gold Shares ETF, sponsored by the World Gold Council, a mining-industry group. Its holdings are valued at more than $16.8 billion, more than the valuation of General Motors Corp.

Each share in GLD is backed by about 1/10 of an ounce of metal held in vaults in London by HSBC Bank USA, a unit of HSBC Holdings PLC. The streetTracks ETF issues more shares as brokers see more demand in the market, and brokers receive shares for the metal they buy and transfer to the fund.

The fund sat on about 628 metric tons of gold last month, according to the World Gold Council, more than the 600 or so metric tons in Chinese central bank reserves and 604 metric tons with the European Central Bank.

In all, the eight ETFs held 834 metric tons of gold through November, according to the World Gold Council.

According to CPM, gold demand among private investors prospecting for returns has nearly doubled to more than 40 million ounces a year since the end of 2001. By contrast, global demand for gold to make jewelry and other items has fallen nearly 13% during the period. Gold's price in the period more than tripled.

Gold was once the linchpin of the global financial system. The value of the dollar was pegged to its value. That relationship formally ended decades ago, but some investors continue to treat it as a kind of quasimoney, something that could hold its value even as the dollar weakens or inflation soars.

That quality is giving it added appeal now. The value of the dollar has dropped 20% against a broad swath of other currencies since 2002 and inflation among other commodities has soared.

A succession of other developments, from the 2001 terror attacks to war in Iraq to the recent mortgage crisis, have added to investor demand for the haven metal.

Originally popular with institutional investors such as hedge funds, such commodity-linked funds now also draw a healthy amount of retail money from everyday investors.

Some investors worry that ETFs such as the streetTracks gold fund have added risks to the already volatile market.

"There's no way the fundamentals justify the rally we've seen," says Leonard Kaplan, president of the commodity-trading firm Prospector Asset Management in Evanston, Ill. Nevertheless, Mr. Kaplan himself is jumping in. He has been buying gold-futures contracts, even though he frets that hedge-fund investment in the commodity is driving it to extremes.

"I have to go along with the market trend right now in order to make money," Mr. Kaplan says. "It could go to $1,200 an ounce in the short term because of sheer momentum."

George Milling-Stanley, manager of investment and market intelligence for the gold council, acknowledges GLD has contributed to the gold rally. But he played down its role amid other drivers such as inflation concerns and the weakness in the U.S. dollar. "There's been a bunch of reasons gold has risen the way it has," he says. "One is easier access via gold ETFs, no question about that."

Write to Peter A. McKay at peter.mckay@wsj.com² and Diya Gullapalli at diya.gullapalli@wsj.com³

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