ETFs Buoy Gold Prices

Due to their increasing popularity, gold exchange traded products, including the SPDR Gold Shares (NYSEArca: GLD), iShares Gold Trust (NYSEArca: IAU) and ETFS Physical Swiss Gold Shares (NYSEArca: SGOL), play important roles in determining the price of the yellow metal.

The aforementioned ETFs are backed by physical gold, meaning the issuers most hold vaulted bullion to provide investors with exposure to the yellow metal. When investors sell shares of these funds, they receive cash, just as they would with equity-based assets.

Gold has enjoyed greater demand in a low interest-rate environment as the hard asset becomes more attractive to investors compared to yield-bearing assets. However, traders lose interest in gold when rates rise since the bullion does not produce a yield.

“Breaking a long trend, demand for gold jewelry in China and India has plummeted in recent years, dragging global demand to its lowest level in seven years,” said Morningstar in a note out Wednesday. “But despite this massive decline in the largest single source of gold demand, prices have proved resilient, largely due to strong investor demand. In the face of ongoing interest rate hikes by the U.S. Federal Reserve, exchange-traded fund holdings have risen to levels last seen in 2013, a period defined by much higher gold prices.”

The good news for gold ETFs is that inflation could serve as a catalyst for the yellow metal. Rising inflation could also prove to be a catalyst for gold ETFs. By some metrics, the Fed has under-estimated U.S. inflation, which could prove beneficial to gold because the yellow metal is historically a popular inflation fighter.

Another possible catalyst for gold entering the back of the year is lingering debate surrounding how many times the Fed can raise rates this year (one more is what many traders are betting on) and in 2018 (three seems to be the bet there).

“ETFs stocked up on gold in a big way in 2016. It was the second-largest accumulation of gold by ETFs in a calendar year, lagging only 2009, which was surprising, since rising real interest rates have historically been associated with ETF outflows,” according to Morningstar.