A Surprise Friend For Gold ETFs

The past few weeks have been unkind to gold and the related exchange-traded funds, but the SPDR Gold Trust (ETF) GLD is still up nearly 7 percent year-to-date.

GLD's year-to-date showing is arguably impressive amid tepid first-quarter demand for quarter. Additionally, the Federal Reserve boosted interest rates in March and many bond market observers believe more rate hikes are coming this year. Higher interest rates usually do not favor gold because the yellow metal offers no interest of its own.

The Fed And Gold's Relationship

Plus, conventional wisdom says a hawkish Fed is dollar positive and what is good for the dollar usually is not good for commodities, gold included. However, gold could be finding an unlikely friend in the Fed.

“Rising interest rates are not typically supportive of gold prices. But after each of the last three Fed interest rate hikes, gold prices have moved higher,” said State Street Global Advisors (SSgA) in a recent note. “Could it be that the Fed’s telegraphed interest rate hike cycle is actually helping gold find upward momentum—and potentially signaling the start of a new gold bull market?”

On the other hand, data suggests inflation is rising, which could bode well for gold ETFs because the yellow metal is often embraced as an inflation hedge.

Accounting for inflation, real U.S. interest rates are in negative territory, further increasing the potential for out-performance by gold relative to other safe-haven assets.

“However, after each hike, the Fed struck a dovish tone. For instance, after its most recent hike, the Fed affirmed only two more expected rate increases for the remainder of 2017. That meant investors’ near-term outlook did not pan out, forcing them to cover their short positions. This essentially created a short-covering rally that boosted gold’s price,” according to SSgA.

That scenario appears to be at play again in the second quarter. Since the start of the current quarter, investors have added $869 million in new assets to GLD, the world's largest gold-backed ETF. That after the March rate hike and after GLD saw first-quarter inflows of $457.5 million.

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