G. Chandrashekhar

Mumbai , July 4

TO what extent can gold exchange traded funds (ETFs) impact gold prices? At the time of launch, it was believed that they would have a positive effect on gold; but current evidence does not bear out the initial promise.

Gold held-in-trust in ETFs in the US, the UK, Australia and South Africa has stagnated in all regions at around 250 tonnes. Further increases were expected, with the product getting rolled out to other countries. But a point of interest that came out in a seminar on gold ETFs held recently under the auspices of the London Bullion Market Association was that so far, these ETFs have tended to stagnate at around 0.03 per cent of the stock market capitalisation of each market.

According to experts, this means that if this product is offered globally, the theoretical potential of the gold ETF would be around 470 tonnes, which is the equivalent (at current prices) of 0.03 per cent of the global stock market capitalisation of $22 trillion. Although this is not an insignificant amount, it is much less than what gold bulls had expected when the product was launched.

Interestingly, 470 tonnes of gold is surely less than one year of India's gold jewellery demand. Any additional demand — even if limited in quantity — is positive for gold. However, the alternative is that it is extremely damaging to the mystique of gold, as it once again very publicly confirms that gold has simply lost its traditional role in the current financial system, commented Mr Kamal Naqvi, Precious Metals Analyst with Barclays Capital.

Even as central banks are clearly devolving themselves from the yellow metal and gold accounts for less than 0.06 per cent of the global forex market, it seems that the `investment potential,' at least in developed countries , is just 0.03 per cent of the stock market, the expert pointed out. No doubt, ETFs are a growing phenomenon and some products see large inflows subsequent to their initial arrival in the market.

Therefore, it is perhaps a little too early to make a final judgment on how much gold investment the ETFs could encourage. However, it is believed that some existing physical demand in bars and coins has been lost to the ETFs and that once a critical mass is reached in an ETF, that much of trading activity can be met by borrowing from the existing stock of ETF shares.

"In summary, gold ETFs are clearly here to stay, but whether they will be the positive factor that was expected is far from clear," Mr Naqvi said.

© Copyright 2000 - 2009 The Hindu Business Line