Due to their status as safe investments, in addition to their many modern industrial uses, precious metals can be affected by several different market factors. Aside from the major economic players like supply and demand and currency devaluation, there are also some more minor factors that are unique to precious metals.
Among these are precious metal ETFs, or exchange-traded funds. ETFs can exert a relatively small but noteworthy pressure on the prices of precious metals, particularly gold. Here’s what all precious metals investors need to know about the relationship between ETFs and spot prices.
What Are ETFs and Why Are They Popular?
Simply put, an ETF is a publicly traded fund that invests in a particular asset. Rather than purchasing the asset itself, some investors purchase shares in the ETF, which reflect a share of the fund’s holdings. Stock ETFs have become popular in recent years because many index funds trade as ETFs. An ETF model, however, can work with any class of assets, including precious metals.
With regards to precious metals investing, ETFs are seen as beneficial to some investors because they eliminate the need to store physical metals. Rather than keeping coins, rounds, or bars, investors can buy ETF shares that reflect a certain percentage of the value of one ounce of a given metal.
Gold is by far the most popular precious metal for ETFs to be based on. The amount of gold that an individual share represents varies from fund to fund, but is typically between one-tenth and one-one-hundredth of a troy ounce.
How Do ETFs Affect Prices?
Since ETF shares are inherently tied to the value of precious metals, investors must buy and sell considerable amounts of physical metal in order to back their shares. In this way, they’re allowed to invest without the need to physically hold metal—a task that’s taken care of by the fund itself. This system makes ETFs some of the largest non-governmental holders of gold in the world. The quantities of gold that ETF investors hold creates some ability to distort the overall market price under certain circumstances.
For instance, when massive amounts of gold are bought or sold on the open market, it temporarily alters the available global gold supply. The result is an upward pressure on prices when large amounts of the available supply are bought, and a downward pressure when they’re sold. Although an individual investor has little effect on these price movements by buying or selling their ETF holdings, large holders like governments can actually buy or sell enough gold to produce a noticeable effect of the global market.
This effect becomes more pronounced the more volatile a market becomes. Under ordinary circumstances with mid-volume trading, ETFs have a very limited impact on prices. In higher-volatility circumstances, though, it’s possible for ETF buying and selling to have a noticeable impact on prices—albeit still a fairly small one.
Could Gold ETFs Pose a Risk in the Future?
Although ETFs currently represent only a modest share of the global gold and precious metals markets, there is some chance that they could grow to become a more popular holding model. ETFs across all asset classes have seen substantial growth in recent years, and some economists and market analysts have voiced concerns over the market distortion such funds could cause if they achieve too large a market share.
Massive ETF trading potential has the ability to produce market shifts that are disproportionately large. For example, if a handful of ETFs own a substantial share or especially a majority of a given asset, their decisions to buy or sell could put significant upward or downward pressure on prices. At that point, the price of gold or any other asset could begin responding to ETF buying and selling, as opposed to the other way around.
With this possibility in mind, it’s important to remember that even the largest gold ETFs are far from being large enough to exert a sizeable influence on spot prices. At the moment, ETFs track spot metal prices fairly closely. Though the risk of significant and continuing price distortion through ETF overgrowth does exist, it’s a fairly remote possibility for the time being. Instead, the effects of ETFs on gold and precious metal prices are small and relatively stable in most market conditions.
Are Gold ETFs Good Investments?
One thing that’s worth noting for investors is that ETF shares are not exclusively based on the price of their relative share of an ounce of gold. Because they are traded, the shares themselves are subject to the same laws of supply and demand that any other asset’s price is driven by. Though shifts in value are quite slight, they have produced some minor value erosion over time. It’s also important to remember that ETFs charge fees for their services, which represent an extra expense to the investor.
To learn more, check out our related article: Physical Metals vs. Futures/ETFs: Which Investment Strategy is Best?
Overall, ETFs can offer some advantages to large holders of gold. General speaking, though, the physical holding of gold is a better investment according to many experts. In addition to the lack of holding fees, physical gold and silver remain free of the influence of investment demands that have gradually produced a slight erosion of the value of ETF shares relative to actual gold.
Be sure to check out the other articles in this series to read about more key factors that impact precious metals prices: