Best of the Week
Most Popular
1.US Paving the Way for Massive First Strike on North Korea Nuclear and Missile Infrastructure - Nadeem_Walayat
2.Trump Reset: US War With China, North Korea Nuclear Flashpoint - Video - Nadeem_Walayat
3.Silver Junior Mining Stocks 2017 Q2 Fundamentals - Zeal_LLC
4.Soaring Inflation Plunges UK Economy Into Stagflation, Triggers Government Pay Cap Panic! - Nadeem_Walayat
5.The Bitcoin Blueprint To Your Financial Freedom - Sean Keyes
6.North Korea 'Begging for War', 'Enough is Enough', is a US Nuclear Strike Imminent? - Nadeem_Walayat
7.Bitcoin Hits All-Time High and Smashes Through $5,000 As Gold Shows Continued Strength - Jeff_Berwick
8.2017 is NOT "Just Another Year" for the Stock Market: Here's Why - EWI
9.Gold : The Anatomy of the Bottoming Process - Rambus_Chartology
10.Bitcoin Falls 20% as Mobius and Chinese Regulators Warn - GoldCore
Last 7 days
Stock Market Calm Before The Storm - 20th Oct 17
GOLD Price Creates Bullish Higher Low - 20th Oct 17
Here’s the US’s Biggest Vulnerability in NAFTA Negotiations - 20th Oct 17
The Greatest Investing Lesson Learned from the 1987 Stock Market Crash - 20th Oct 17
Stock Market Time to Go All-in. Short, That Is - 19th Oct 17
How Gold Bullion Protects From Conflict And War - 19th Oct 17
Stock Market Super Cycle Wave C May Have Started - 19th Oct 17
Negative Expectations, Will the Stock Market Correct? - 19th Oct 17
Knowing the Factors Affect your Car Insurance Premium - 19th Oct 17
Getting Your Feet Wet In Crypto Currencies - 19th Oct 17
10 Years Ago Today a Stocks Bear Market Started - 19th Oct 17
1987 Stock Market Crash 30th Anniversary Greatest Investing Lesson Learned - 19th Oct 17
Virgin Media Broadband Down, Catastrophic UK Wide Failure! - 19th Oct 17
The Passive Investing Bubble May Trigger A Massive Exodus from Stocks - 18th Oct 17
Gold Is In A Dangerous Spot - 18th Oct 17
History Says Global Debt Levels Will Lead to Another Crisis - 18th Oct 17
Deflation Basics Series: The Quantity Theory of Money - 18th Oct 17
Attractive European Countries for Foreign Investors - 18th Oct 17
Financial Transcription Services – What investors should know about them - 18th Oct 17
Brexit UK Vulnerable As Gold Bar Exports Distort UK Trade Figures - 18th Oct 17
Surge in UK Race Hate Crimes, Micro-Racism, Sheffield, Millhouses Park, Black on Asian - 18th Oct 17
Comfortably Numb: Surviving the Assault on Silver - 17th Oct 17
Are Amey Street Tree Felling's Devaluing Sheffield House Prices? - 17th Oct 17
12 Real-Life Techniques That Will Make You a Better Trader Now - 17th Oct 17
Warren Buffett Predicting Dow One Million - Being Bold Or Overly Cautious? - 17th Oct 17
Globalization is Poverty - 17th Oct 17
Boomers Are Not Saving Enough for Retirement, Neither Is the Government - 16th Oct 17
Stock Market Trading Dow Theory - 16th Oct 17
Stocks Slightly Higher as They Set New Record Highs - 16th Oct 17
Why is Big Data is so Important for Casino Player Acquisition and Retention - 16th Oct 17
How Investors Can Play The Bitcoin Boom - 16th Oct 17
Who Will Be the Next Fed Chief - And Why It Matters  - 16th Oct 17
Stock Market Only Minor Top Ahead - 16th Oct 17
Precious Metals Sector is on Major Buy Signal - 16th Oct 17
Really Bad Ideas - The Fed Should Have And Defend An Inflation Target - 16th Oct 17
The Bullish Chartology for Gold - 15th Oct 17
Wikileaks Mocking US Government Over Bitcoin Shows Why There Is No Stopping Bitcoin - 15th Oct 17
How to Wipe Out Puerto Rico's Debt Without Hurting Bondholders - 15th Oct 17
Gold And Silver – Think Prices Are Manipulated? Look In The Mirror! - 15th Oct 17
Q4 Pivot View for Stocks and Gold - 14th Oct 17
Gold Mining Stocks Q3’17 Preview - 14th Oct 17
U.S. Mint Gold Coin Sales and VIX Point To Increased Market Volatility and Higher Gold - 14th Oct 17
Yuan and Gold - 14th Oct 17
Tips for Avoiding a Debt Meltdown - 14th Oct 17

Market Oracle FREE Newsletter

3 Videos + 8 Charts = Opportunities You Need to See - Free

Radical Gold GLD ETF Under Investment

Commodities / Gold and Silver 2015 Jun 05, 2015 - 05:11 PM GMT

By: Zeal_LLC

Commodities

Gold remains deeply out of favor thanks to global central banks’ extreme money printing.  This fueled a global stock-market levitation that has temporarily short-circuited normal market cycles, leaving investors infatuated with stocks to the exclusion of prudent portfolio diversification.  This has left them radically underinvested in gold, which sets the stage for massive mean-reversion buying when they inevitably return.

Portfolio diversification is an absolutely essential tool for investment risk management.  This simple and powerful wisdom is ancient, as a three-millennia-old quote from the Israeli king Solomon reveals.  He advised, “Invest in seven ventures, yes, in eight; you do not know what disaster may come upon the land.”  Indeed history has proven countless times that putting all one’s eggs in one basket is foolish.


And that doesn’t just mean diversifying portfolios across individual stocks, but entire asset classes.  The vast majority of stocks are highly correlated with each other, and the general stock markets.  So when the next major selloff inescapably arrives, individual stocks are all going to spiral lower together.  While owning different stocks mitigates individual-company risks, it has very little diversification value in major selloffs.

So throughout the dozens of centuries since the super-wise Solomon opined on portfolio diversification, the truly smart investors have diversified across asset classes.  While they owned stocks or whatever the equivalent ownership stake in businesses was in their time, they also owned the local bond equivalent, real estate, and precious metals.  Because of its unique behavior, gold is the most important diversifier of all.

Stocks are highly correlated with each other, and the stock markets as a whole are highly correlated with the broader economy.  And so are bonds and real estate.  So when the market cycles inexorably turn and a new bear market begins, these portfolio mainstays all drop together.  The precious metals are the only major asset class with a strong inverse correlation to stock markets, they thrive when stocks are weak.

Prudent investors have always understood gold’s indispensable roll in portfolio diversification.  The best financial advisors throughout history have recommended all investors have 5% to 20% of their portfolios in gold.  It is the ultimate portfolio insurance, tending to rally dramatically when everything else sells off.  But thanks to the extreme central-bank distortion in the stock markets today, gold has been left for dead.

Stock markets normally meander in endless bull-bear cycles, driven by valuations.  But in early 2013, the Fed’s unprecedented open-ended third quantitative-easing campaign started short circuiting them.  The Fed was aggressively conjuring money out of thin air to buy bonds.  And Fed officials kept on hinting that they would ramp up these debt monetizations if the stock markets fell materially, greatly altering psychology.

Normally investors are wary of periodic healthy selloffs that rebalance sentiment, and act accordingly.  But with the Fed effectively backstopping stock markets, this prudence vanished.  Every selloff since early 2013 was quickly nipped in the bud.  Buy-the-dippers rapidly flooded back in, usually on direct Fed-official jawboning.  Eventually, investors started believing that serious stock selloffs can’t happen anymore.

So they forgot about prudent portfolio diversification, and moved all their capital into that stocks basket.  They bought into the Fed-fostered fantasy that the stock markets were essentially riskless as long as Fed policy remained super-accommodative.  So they abandoned gold, leading to today’s situation of radical underinvestment in this essential negatively-correlated portfolio asset class.  This extreme anomaly won’t last.

American investors have probably never been close to even having 5% of their portfolios in gold, the lower end of the historical best practice.  But we can still approximate how much their gold exposure has plunged in these recent Fed-distorted years.  This is evident through comparing two key metrics, the capital invested in the GLD gold ETF and the collective market capitalization of the elite S&P 500 companies.

GLD is the world’s dominant gold ETF, and acts as a conduit for the vast pools of stock-market capital to flow into and out of physical gold bullion.  It is the cheapest, easiest, and fastest way for stock investors to get gold exposure in their portfolios.  And of course the S&P 500 (SPX) is the flagship benchmark US stock index, containing the biggest and best US companies.  The contrast between the two is illuminating.

This week, the gold bullion held by GLD on behalf of its shareholders was worth $27.1b.  Meanwhile the total market cap of all SPX companies was $19,729.8b.  Run these numbers, and it suggests American stock investors’ total portfolio exposure to gold is just 0.14%.  That’s far too trivial to offer any portfolio diversification at all.  And such radical gold underinvestment is very atypical, even in the gold-agnostic US.

Back in December 2012 just before the Fed’s incredibly-manipulative QE3 campaign kicked into full gear, GLD’s holdings were worth $74.1b.  That worked out to 0.56% of the SPX components’ market cap.  While still low, that was a whopping 4.1x higher than today’s anomalous levels.  And back in August 2011 the last time gold was really in favor, this GLD-holdings/SPX-market-cap ratio climbed to 0.79%.

So even in recent history, relative gold investment as a percentage of stock investors’ portfolios was 5.8x higher than today’s levels!  This reveals how extreme today’s gold underinvestment by American stock investors is.  Their portfolio gold exposure today via GLD is only around 1/6th of peak levels relative to stocks, and about 1/3rd of absolute levels in terms of capital invested in GLD.  This is super-bullish for gold!

At some point soon here, these central-bank-levitated world stock markets are going to roll over hard.  History is crystal-clear in proving that central-bank money printing can only amplify and stretch market cycles, it can never nullify them.  And as investors face the first major stock-market selloff since way back in late 2011, they are going to scramble to buy gold.  It will be rallying strongly while everything else is falling.

As the vast pools of stock capital start migrating back into GLD, it will be forced to shunt these inflows directly into physical gold bullion.  GLD acts as a conduit for stock-market capital to flow into and out of physical gold.  That’s the only way GLD can maintain its mission of tracking the gold price.  Since the supply and demand for GLD shares is independent of gold’s own, GLD’s managers have to actually buy and sell gold.

When GLD shares are being bought faster than gold itself is being bought, this ETF’s price threatens to decouple to the upside and fail to mirror gold.  So GLD’s managers must offset this differential buying pressure by issuing sufficient new shares to satisfy this excess demand.  The capital raised is then used to buy physical gold bullion held in vaults for GLD’s shareholders.  Stock capital flows into gold via GLD.

But capital pipelines work both ways.  When investors sell GLD shares faster than gold is being sold, its price will disconnect to the downside.  GLD’s managers have to buy back enough shares to sop up this excess supply.  They raise the necessary capital to do so by selling some of GLD’s holdings of gold bullion.  So stock capital also flows out of gold through GLD, which is what has happened in recent years.

Since the dawn of full-strength QE3 in early 2013, investors have wholesale abandoned gold in favor of Fed-levitated stock markets.  This chart shows the quarterly changes in GLD’s holdings, reflecting the massive outflows of stock investors’ capital from gold.  This extreme selling peaked in Q2’13, when GLD’s holdings plummeted by 251.8 metric tons as investors fled.  That drove gold’s worst quarterly loss in 93 years!

Overall between December 2012 and GLD’s recent extreme 6.3-year holdings low in January 2015, investors dumped so many GLD shares that it was forced to liquidate 648.5t of gold!  That works out to about 25.9t of gold per month.  These epic outflows were so great that they overwhelmed normal gold investment demand, forcing gold’s price sharply lower.  Gold was above $1700 right as GLD’s epic selloff started!

Gold investors need to realize how incredibly important stock-market capital flows have become for prevailing gold prices.  The amount of capital invested in the stock markets is enormous, dwarfing gold.  So when stock investors are buying or selling gold in a big way via GLD, the resulting capital shunted into or out of physical gold bullion has a dominating price impact.  This is readily evident in this chart.

Note how closely the red gold price correlates with the blue GLD bullion holdings in recent years.  Gold could only rally significantly after GLD’s holdings stabilized and started rising again.  This proved true in Q3’13, Q1’14, Q2’14, and Q1’15.  Whenever GLD’s holdings were falling, indicating differential selling pressure on GLD shares, gold slid in unison.  The additional gold supply spewed by GLD came too fast to absorb.

So if you want to know which way gold is likely heading next, look to GLD.  When stock investors have high gold exposure via this ETF, that indicates that gold is likely in favor and in danger of topping.  And when they have low gold exposure like today, gold is out of favor and likely bottoming.  So the best time to invest in gold is when GLD’s holdings are low, since stock investors have little portfolio-diversifying gold.

And that describes today’s conditions perfectly, as the radical gold underinvestment has manifested in GLD.  Thanks to the euphoric global stock markets in recent months, and investors’ irrational belief that central banks have miraculously eradicated stock-market cycles, GLD’s holdings have slumped considerably.  This week they were just 0.7% above their extreme early-January-2015 low, which is intriguing technically.

GLD’s holdings look to be carving a massive double bottom.  Even though gold was weak while central-bank-goosed stock markets surged to record highs as 2014 ended, GLD’s holdings stopped falling.  That strongly suggests stock investors reached selling exhaustion on gold.  All of them susceptible to being scared into selling low had already done so, leaving only buyers.  This next chart zooms in on that bottoming.

As gold fell deeply out of favor in early January 2015, bearish commentary abounded.  Everyone, even most of the long-time gold bulls, was forecasting major new lows soon.  Sentiment was overwhelmingly pessimistic, with all hope seeming lost for gold.  Yet the darkest, most-out-of-favor times are right when markets are ripe for sharp reversals.  And that’s exactly what happened in GLD as investors flooded back in.

As gold itself started surging higher on heavy buying by American futures speculators, stock investors quickly pounced on this momentum and aggressively bought GLD shares.  Their serious differential buying pressure catapulted GLD’s holdings higher as its managers shunted all those excess capital inflows into physical gold bullion.  So January enjoyed GLD’s best monthly holdings build since November 2011!

And with GLD’s holdings once again slumping back down near those same early-January levels that marked a selling-exhaustion bottoming, another sharp reversal is likely imminent.  Some catalyst is nearing that is going to reignite stock investors’ demand for gold.  I suspect it will be a sustained and decisive selloff in these wildly-overextended and overvalued US stock markets, which is long overdue.

While the Fed hasn’t started unwinding any of the past 6.5 years’ extreme bond buying yet, it is rapidly nearing the end of its zero-interest-rate policy launched in December 2008.  This will begin the Fed’s first rate-hike cycle in 9 years.  Higher interest rates are very damaging to overvalued stock markets, and this coming rate-hike cycle is exceptionally risky.  The Fed has never before normalized out of zero rates!

As the resulting adverse stock-market reactions and sheer uncertainty mount, stock investors are going to remember that ancient wisdom of prudent portfolio diversification.  They are going to try and mitigate the growing losses in their stock-heavy portfolios by shifting some capital back into GLD.  And since the gold market is so small relative to the stock markets, it won’t take much capital inflows to catapult gold higher.

Once this whole mean-reversion process gets decisively underway for the stock markets and gold, it isn’t likely to stop until it has fully run its course.  That means investors have a long ways to go to return their gold portfolio allocations to more reasonable levels.  While gold-skeptic American stock investors will probably never get to 5% of their portfolios allocated to gold, they will go far higher than today’s dismal 0.14%.

Remember that GLD’s holdings have been up to 6x higher in recent years relative to the S&P 500 components’ collective market capitalization.  I have no doubt we will see those 0.79% levels again in the coming years.  GLD’s holdings will almost certainly exceed 1% of the SPX’s market cap the next time gold really returns to favor.  But to be super-conservative, let’s just assume this allocation grows 3x to 0.42%.

It will probably at least take a full-blown correction approaching 20% in the S&P 500 to drive stock investors’ demand for portfolio-diversifying gold via GLD that high.  It’s been far too long since hyper-complacent stock markets have seen one thanks to the Fed’s gross distortions.  That would drag the S&P 500’s market cap back down to $15,905.8b.  Multiplying that by 0.42% gold exposure via GLD is very bullish for gold.

This yields GLD’s holdings climbing back up to $66.8b.  That is nearly 2.5x more capital invested in GLD than today’s levels!  And as the sharp gold rallies in recent years partially fueled by GLD buying proved, that would really light a fire under gold.  Assuming gold was about 25% higher than today near $1500, still way below its pre-QE3 2012 average around $1675, would yield GLD holdings back up near 1385 tonnes.

That is nearly double today’s levels, yet still barely above December 2012’s record of 1353.3t.  And even if an SPX correction is not sufficient to drive this, even if it takes an overdue 50% bear market, so much GLD buying will massively boost the gold price.  Stock bear markets take about a couple of years to unfold.  And even at that pace, this mean reversion higher of GLD’s holdings works out to 28.1t of new monthly buying.

According to the World Gold Council, in all of 2014 global gold investment demand averaged 68.4t a month.  So American stock investors ending their radical gold underinvestment and returning to GLD could boost this on the order of 40% for a long time.  And that doesn’t include the big coming buying from American futures speculators, another large pool of capital with an outsized influence on gold price levels.

So as today’s radical gold underinvestment as manifested in GLD’s holdings inevitably reverses and mean reverts back to normal levels, gold investment demand is going to soar.  This will naturally power gold’s price much higher, unleashing gold’s first major upleg of this post-QE era.  And the Fed’s coming rate hikes are nothing to fear, as gold actually thrives in rising-rate and high-rate environments!

While gold and GLD will enjoy great gains as stock investors inevitably return, they will be dwarfed by those in the left-for-dead gold miners’ stocks.  Late last year they were battered down to fundamentally-absurd levels relative to the gold price which drives their profits.  So they are poised to rally dramatically as soon as gold turns around, with the greatest potential gains by far of any sector in all the stock markets.

At Zeal we’ve been aggressively buying the best of these beaten-down gold and silver stocks in recent months, as have been recommended in our acclaimed weekly and monthly subscription newsletters for contrarians.  They draw on our exceptional market experience, knowledge, and wisdom forged over decades to explain what’s going on in the markets, why, and how to trade them with specific stocks.  Subscribe today, as we’re currently running a popular 33%-off Contrarian Extinction Sale!

The bottom line is American stock investors are radically underinvested in gold, as evidenced by GLD’s low gold-bullion holdings.  This is a result of the Fed’s artificially-levitated stock markets of recent years, which duped investors into forgoing prudent portfolio diversification.  As the stock markets roll over, gold is going to return to favor in a big way.  It is the only major asset class strongly inversely correlated with stocks.

As these lofty stock markets sell off, stock investors will flock back to GLD.  All their differential buying pressure will force this ETF’s managers to shunt great amounts of capital directly into physical gold bullion.  That will really accelerate gold’s coming upleg, triggering even more GLD buying.  Investors who buy in ahead of this coming major mean reversion in gold investment demand stand to make fortunes.

Adam Hamilton, CPA

So how can you profit from this information? We publish an acclaimed monthly newsletter, Zeal Intelligence , that details exactly what we are doing in terms of actual stock and options trading based on all the lessons we have learned in our market research. Please consider joining us each month for tactical trading details and more in our premium Zeal Intelligence service at … www.zealllc.com/subscribe.htm

Questions for Adam? I would be more than happy to address them through my private consulting business. Please visit www.zealllc.com/adam.htm for more information.

Thoughts, comments, or flames? Fire away at zelotes@zealllc.com . Due to my staggering and perpetually increasing e-mail load, I regret that I am not able to respond to comments personally. I will read all messages though and really appreciate your feedback!

Copyright 2000 - 2015 Zeal Research ( www.ZealLLC.com )

Zeal_LLC Archive

© 2005-2017 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Post Comment

Only logged in users are allowed to post comments. Register/ Log in

Catching a Falling Financial Knife