Gold Exchange Traded Fund and Gold Price Volatility

Since the creation of gold exchange traded funds in the United States and world-wide in the last decade investment in the precious metal has exploded. The resulting expansion by both large and small scale investors into various global gold exchange traded funds has at times put increasing price pressure on the precious metal. The pressures associated with investing in gold may have finally come to a head in late 2011 and investors are wondering whether 2012 will mark a turn away from gold's glittering ETFs.

Rising Trend of Physical Gold Demand
According to the World Gold Council the evidence of an increased demand for direct investment in gold bars and coin has been steadily consuming a greater portion of the available gold production supply. Production of the yellow metal has remained more or less steady for the last several years, making the additional coin and bar demand a deciding factor in price movements. Much of this demand and price movement has come in reaction to the rising global uncertainty and multiple bank failures stemming from the Lehman collapse of 2008. Certain classes of financial investors poured resources into gold exchange traded funds which was followed on by the aforementioned rapid increase physical coin and bullion demand.

Periodic Rushes into Gold Exchange Traded Funds Exacerbate Swings
Financial assets are designed to be much more liquid (and hence more fickle) than physical assets, and it then comes as no surprise that periodic jumps in funds pouring into gold exchange traded funds produced coincidental spikes in spot gold prices. Evidence of this is clear in the World Gold Council figures from Q2 2010 (subsequent to the end of the first round of US Quantitative Easing in Q1 2010), where spot prices jumped 8.5% quarter over quarter. Steady ETF demand through the end of the year combined with increased interest in physical delivery of precious metal assets jumped prices another 14% by year end 2010. The success of the squeeze put on by financial and physical gold buyers in 2010 emboldened the cause in 2011. The announcement of a second round of quantitative easing beginning in late 2010 drove even more buyers to the physical market in 2011 - pushing prices up another 24% by the end of Q3 2011.

Q4 2011 and Calendar Year 2012 Supply/Demand Imbalance Seen Likely
While final figures are not yet in for the fourth quarter of 2011, something clearly broke in the supply/demand pattern. The imbalance created by the massive price runup (peaking another 11.8% up in August 2011) resulted in wild swings for the balance of the year. By the end of the 4th quarter gold prices had dropped precipitously off their highs by nearly 20% - taking some of the lustre off of gold exchange traded funds' returns. A number of the best gold ETF companies posted near double digit returns in spite of the December spot price fall-off.

Was The Late Price Shift a Sign of Things to Come?
The sudden price shift in late 2011 indicates a change may be underway in global trends in 2012. Price spikes in gold caused net demand to drop in traditional uses such as jewelry and the suspicion here is that financial asset investors bolted for the exits in late 2011 - leaving the physical gold investors holding the bag. It remains to be seen whether the largest gold exchange traded funds such as the iShares Gold Trust (IAU) or the SPDR Gold Trust (GLD) will be net buyers or sellers in 2012, but I think we can be fairly certain that a glut of supply of gold came on the market in late 2011 which put a severe bump in the short term supply/demand curve.