The explosive growth of precious metals-linked exchange traded funds has prompted some market watchers to warn that those shiny investment vehicles could increase the speed and depth of a future crash.
Both gold and silver hit all-time highs on Thursday, with gold near $1,535 an ounce and silver near $50, extending rallies after the U.S. Federal Reserve said on Wednesday it would not tighten its monetary policy in the near term, which weakened the U.S. dollar to a three-year low.
Gold is often used as a currency and inflation hedge.
Commodity-linked ETFs have benefited from the big run-up in precious metals and many say they've helped fuel the rally.
State Street's SPDR Gold Trust, which trades on the New York Stock Exchange under the symbol GLD, was the first U.S. gold ETF, launching in late 2004.
It sells shares based on the price of 1/10th of an ounce of gold, along with a fee of 40 basis points, making it cheaper and easier for the average investor to get exposure to physical gold bullion without worrying about where and how to store it.
GLD now has over $60 billion in assets and more than 1,200 tonnes (metric tons) of gold backing up its securities.
To put that into perspective, GLD sits sixth among the world's top gold holders, behind the United States, Germany, the IMF, Italy, and France.
In early 2005, BlackRock's iShares came out with a gold ETF under the symbol IAU. One share equals 1/100th of an ounce of gold, giving investors a cheaper entry point. It has around $6.5 billion in assets, 134 tonnes of gold, and a fee of 25 basis points.
"We can't ignore the fact that such a gorilla has landed on the scene and I reckon that it probably has added a good $300 to the price equation," Jon Nadler, senior metals analyst at Kitco Metals in Montreal, said of the impact of gold ETFs on the price of the metal.
His concern is that because hedge funds are big investors in gold ETFs, once they have reached their profit targets, or sense the interest rate environment is changing, they will sell their substantial stakes and take their dollars elsewhere.
That sizable outflow, which he said could be in the range of 200 tonnes to 300 tonnes -- or 10 percent or more of the total holdings of gold ETFs — could cause a sharp drop in the price of gold to $900 or lower.
But Tom Anderson, global head of ETF strategy and research at State Street Global Advisors, argued that if the hedge funds that own GLD shares all bailed out, it would be an orderly process.
"GLD trades $2 billion worth of shares every single day, so there is an awful lot of liquidity in that product, so it could absorb an awful lot of selling just in the course of its daily business," he said.
The International Monetary Fund warned in its recent Global Stability Report that strong flows into commodity-based ETFs, especially gold ETFs, have been partly responsible for the recent rise in commodity price volatility.
Net inflows to gold EFTs were around $12 billion in 2009, and another $9 billion in 2010, during which time gold prices surged 62 percent. In January, gold ETFs had outflows of $3 billion, which the IMF said drove prices sharply lower.
That raised concerns that, if investors were to move out en mass from other commodity-based funds, it could rile the markets and hit the price of related sector indexes.
State Street's Anderson argued that for the first quarter of 2011, gold ETFs have experience net outflows, but the price of gold has continued to rise.
"Demand has certainly increased, but it's for a whole host of reasons, not just ETFs," he said.
Mark Williams, a risk-management expert at the Boston University School of Management's Finance Department, and a former Federal Reserve Bank examiner, said he is concerned about what affect gold ETFs will have on the price of gold and other precious metals when they are in a bear market.
"Silver is up, what, 150 percent in the last year, 52 percent this year," he said. "As we know in these commodities, as the prices increase, it creates more demand for speculators to jump in, so think of that, as prices drop on gold, that would create more demand for speculators to get out."
The last time that gold crashed, in 1980, it dropped by 60 percent in one year, and that was before ETFs, said Williams.
Demand for precious metals will likely drop when the global economy begins to pick up, he said, which could shift investor sentiment more to equities.
"Investors are going to say a portion of my investments should be in gold, but there are other investments — gold doesn't produce dividends, gold doesn't produce a product, gold's expensive to store, why don't I invest in Apple?"
Meantime, investors have continued to buy gold, with the University of Texas buying nearly $1 billion in gold bullion earlier this month. And while GLD had big outflows early in the year, Anderson said that so far in April inflows into GLD have been around $860 million.
For Kitco's Nadler, the recent inflows and price increases don't change anything.
"Whenever you hear, 'this time is different,' those are the four most expensive words in the English language," he said.
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