Gold Liquidity Is Plunging, Here’s What Comes Next

After getting crunched last week, precious metals are rising once more. Gold is doing especially well in that regard following Warren Buffett’s investment in Barrick Gold (NYSE: GOLD), a popular miner.

But the other major trend in the gold market this year – besides the recent rally – is the enormous investor inflow into gold-backed exchange-traded funds (ETFs). Moreover, that ETFs have dramatically increased their holdings of physical gold in response to those inflows.

The World Gold Council, which is the chief sponsor of the SPDR Gold Trust (NYSE: GLD), reported on this trend several weeks ago in a revealing Twitter post:

“In July, [gold ETFs] recorded their eighth consecutive month of positive flows, adding 166t, equivalent to US$9.7bn AUM. Once again, this brought global holdings to a new all-time high.”

Gold ETFs have seen their holdings grow by 21% in 2020. In July, they logged their eighth consecutive month of physical gold inflows, contributing to a streak of record highs.

The biggest gold-hoarder of them all, though, was the aforementioned SPDR Gold Trust, which added 348 tons of gold from January – July of this year. 333 of those tons were added since late March alone.

In total, the SPDR Gold Trust now has 1241 tons of gold, held with HSBC Bank in London.

That’s a lot of physical gold. And for the SPDR Gold Trust, it’s been getting harder to find. In April, HSBC tapped the Bank of England for a major gold bar transfer. In a Q1 2020 filing to the SEC, the SPDR Gold Trust revealed that it began holding gold bars at the Bank of England – roughly 46 tons, or 4.4% of the ETF’s total holdings.

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And though an ETF procuring more gold wouldn’t normally raise eyebrows, the SPDR Gold Trust’s April maneuver was somewhat of an anomaly.

Save for one occasion in 2016, the SPDR Gold Trust has never had to source and store gold outside of HSBC’s London vault.

Then, in Q2 2020, the SPDR Gold Trust published its most recent SEC filing, in which investors learned that the ETF increased its Bank of England gold holdings to 70 tons by the end of May, representing 6.3% of GLD’s gold supply.

And even at the end of June, SPDR Gold Trust reported that 40 tons of its gold were still being held in the Bank of England’s vault.

This might not seem like a big deal at first glance. After all, gold-backed ETFs need to hold large amounts of gold.

However, the SPDR Gold Trust’s reliance on the Bank of England implies something that could have a profound effect on the gold market, which is that there is a shortage of physical floating gold.

In other words, the amount of freely tradable gold is dwindling while liquidity plunges. The physical gold market is very small relative to the equity gold market (ETFs), making this a potentially critical trend that could have major implications for both physical gold and gold-backed ETF investors.

If this continues, gold-backed ETFs might not be able to buy enough gold as demand surges. Physical gold would explode higher as a result while the ETFs start to lag behind, or even worse, start to fall.

We’re not there yet – not even close – but it’s a possible outcome should the physical gold float drop to near-zero.

So, while buying shares of GLD to participate in the gold boom may be convenient, it might not be the safest long-term strategy. Physical gold, or even gold miners, could be the better buy.

Especially once other investors start to recognize the gold market’s drop in liquidity and begin to shift their precious metals portfolios.

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