ETF Investors Flock to Gold in February

February was another brutal month to be long in equities. Market participants were blitzed with streams of negative economic data, reports of massive job losses, and rumors of bank nationalization. To make matters worse, market confidence was all but shattered as the market balked at the $787 billion  stimulus plan signed into law by President Obama and greeted the administration's budget with a healthy dose of skepticism.

If there's one thing Wall Street doesn't like, it's uncertainty. So in response to the unveiled policy measures (as well as the lack of clarity surrounding those policies), markets continued to sell off. Now, the marked selling pressure that has become commonplace with financial-, real estate-, and retail-related stocks is spreading to industries once characterized as defensive--namely utilities and health care. The barrage of downbeat news hitting the wires, coupled with heightened uncertainty, helped the market plunge through the current cycle lows it set in November. The last time we saw the S&P 500 Index near current levels Michael Jordan was winning NBA titles with the Chicago Bulls and folks were using Netscape to browse the Internet.

There seems to be few places (if any) to hide in this tumultuous market. With that in mind, we examined Morningstar's detailed fund flow data to see what ETF investors were buying and selling during this action-packed month.

ETFs with Largest Net Redemptions--February 2009
	Net Outflow ($Mil)	AUM ($Mil)	YTD % Change	Expense Ratio (%)
SPDRs (SPY)	-12,237	62,704	-21.90	0.88
iShares MSCI EAFE Index (EFA)	-1,139	23,224	-23.17	0.35
UltraShort Real Estate ProShares (SRS)	-908	1,140	86.09	0.95
iShares Russell 2000 Index (IWM)	-887	6,930	-26.13	0.20
PowerShares QQQ	-705	10,264	-10.93	0.20
Data as of 2-28-2009.

The results should come as no surprise to attentive market observers. So far this year, investors have been yanking assets from ETFs that track broad market indexes, while parking their cash in gold, oil, and TIPS. Taking a top-down view of the markets, it's easy to see why investors might be lightening up on their equity exposure. Remember, broad market indexes court exposure to all corners of the economy. Given the fact that we're currently facing one of the most challenging economic periods since the Great Depression, it's no wonder that some near-to-intermediate term money is fleeing equity markets.

A look at the specific funds investors were selling in February reveals that negative market sentiment spans the Morningstar Style Box and reaches across the pond. As illustrated by the table below, investors--much as they did in January--continued to bail on U.S. large-caps ( SPDRs (SPY) and  Qubes ), international large caps ( iShares MSCI EAFE Index (EFA)), and U.S. small caps ( iShares Russell 2000 Index (IWM)).

On a brighter note, investors who recently sold UltraShort Real Estate ProShares (SRS) (an ETF designed to deliver twice the inverse of  iShares Dow Jones US Real Estate (IYR)) have plenty to cheer about; that fund is up a scorching 86% for the year to date through the end of February. But, before rushing out to invest any retirement savings into a leveraged or inverse ETF with the idea of recouping losses, please read this article, which explains that you could very well have the correct investment thesis and still suffer large losses due to volatility drag and negative compounding.

Shifting to ETFs that experienced the largest net inflows, the first thing that jumps out is that only one equity-based fund made the cut:  Market Vectors Gold Miners ETF (GDX), which is essentially a levered bet on the price of gold. Investors seeking shelter from the unrelenting assault on equities appear to be looking for alternative stores of value while waiting out the ongoing economic storm. After an impressive showing in 2008, U.S. Treasuries are currently offering miniscule yields and paltry expected returns. Furthermore, while confidence in the domestic banking system has been badly bruised, foreign banks are suffering from similar, if not worse, problems.

As a result, demand for precious metals, particularly gold, has increased. Another gold-based ETF,  SPDR Gold Trust (GLD), is now the second-largest ETF behind SPDRs. GLD also recently surpassed Switzerland to become the world's sixth-largest holder of gold bullion. For more insight and analysis on the shiny yellow metal and its potential role in one's portfolio, see ETF Strategist Paul Justice's recent articles here and here.

While the Fed's immediate efforts are targeted at preventing a bout of deflation, the long-term consequences of its loose monetary policy are inflationary. That bodes well for gold prices over the long haul. As a hard asset, Oil should also benefit down the road as inflation heats up. Hence,  United States Oil  (USO) made the top five for inflows for the second month in a row. The fund has become popular, as it allows investors to bet on a rebound in the price of oil while avoiding the oil companies themselves, which have come under fire as a result of new reforms coming out of Washington. Finally, the future for  iShares iBoxx $ Invest Grade Corp Bond (LQD) is much brighter following the deal that  Citigroup (C) struck with the government to convert preferred securities into common equity in lieu of raising additional capital (while common equity gets severely diluted, debt securities remain intact).

ETFs with Largest Net Inflows--February 2009
	Net Inflow ($Mil)	AUM ($Mil)	YTD % Tot Ret	Expense Ratio (%)
SPDR Gold Shares (GLD)	5,690	31,496	8.27	0.40
Market Vectors Gold Miners ETF (GDX)	1,051	3,817	-1.34	0.55
United States Oil (USO)	892	3,920	-28.43	0.86
iShares iBoxx $ Invest Grade Corp Bond (LQD)	860	8,651	-3.84	0.15
iShares Barclays TIPS Bond (TIP)	841	10,232	0.45	0.20
Data as of 2-28-2009.

After gathering about $2.2 billion in assets in January, ETFs experienced net redemptions of approximately $4.8 billion in February. We don't view this as a reversing trend, but rather a transition period as market participants absorb the flurry of new information that surfaces daily. Looking back, ETFs attracted approximately $157.9 billion in assets in 2008 (representing 22% growth in cash inflows versus 2007). The interesting thing to note here though is that cash inflows really picked up when fear and uncertainty in the markets seemed to be at their peaks; $141.9 billion out of the $157.9 billion that ETFs attracted in 2008 came in the second half of the year. When investors are ready to get back into risk assets, we think they'll find the transparency, low costs, and intraday liquidity that ETFs provide very compelling.

 

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Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors (BGI), First Trust, and ELEMENTS, for use in exchange-traded funds and notes. These ETFs and ETNs are not sponsored, issued, or sold by Morningstar. Morningstar does not make any representation regarding the advisability of investing in ETFs or ETNs that are based on Morningstar indexes.