ETF Activity Suggests Gold May Be Getting A Bit Too Fashionable Right Now

The “flight to quality” mood that has pushed gold up to $1800 in August 2011 has caused a lot more people to get interested in gold.  And it has sucked a lot of money into GLD and IAU, the two biggest gold bullion ETFs.  When we see a big surge of assets invested in these ETFs, it can be a useful indication of investor sentiment about gold generally.

Before GLD debuted in 2004, we used to watch the action in the Central Fund of Canada (CEF), a closed end fund that owns gold and silver bullion.  It would trade at a premium or discount to its net asset value (NAV), as demand waxed and waned.  When investors were willing to pay a 10% premium over the value of the bullion just to own a share of it, that was a good sign that people were a little too excited about gold.

That indication stopped working when gold ETFs came about, because when the ETFs trade very close to NAV there is no need for anyone to pay a premium to own shares of CEF.  But GLD and IAU bring their own interesting sentiment indication from watching the money flowing in and out.  You can get the raw data from the SPDR Trust and IAU Trust in Excel format.

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The big run up to $1800 has attracted more money to GLD and IAU.  When there are more people who want to buy shares than sell at the current NAV, the trusts issue more shares and buy more bullion to back them.  The opposite happens when gold prices decline, and people start wanting to sell.

But just looking at the raw level of total tonnes (1000 kg) held is not enough to get a clear sentiment indication.  There are no empirical “high” and “low” levels.  What I like to do to better measure the changes is to look at a 2-week rate of change indicator.

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When we see total tonnes change by more than 2% up or down over a period of two weeks, it is a sign that the crowd is rushing in or out quickly enough to show significant crowd behaviour.  On Aug. 8, the 2-week rate of change (ROC) jumped all the way up to +5.4%, which is the biggest jump since the summer of 2010.  Gold, it seems, is becoming a little bit too fashionable, at least for the moment.

In terms of this sentiment indication, there is no information about where gold prices are ultimately headed in the long run.  This just gives us an insight into whether prices have run a little too far and too fast.  A meaningful pullback would likely send all of the recent converts running, and so if you see a significant drop in this asset data you can know that sentiment has swung far back the other way, setting up for the next bottom opportunity.  This information is something we share with readers of our twice monthly McClellan Market Report newsletter and Daily Edition when its indication warrants.  Click here to see samples of those.

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