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Exchange traded funds have transformed the gold market. Since the first fund was launched nearly a decade ago, the products have become so successful in offering a simple way for investors to buy physical gold that they have acquired the nickname "the people's central bank."

But what happens when the people's central bank decides to sell?

That is the question now haunting the bullion market. Since the start of January, gold ETFs have dumped 140 tonnes of gold. February saw the largest monthly outflow of gold from ETFs on record.

The sell-off is partly a reflection of broader negative sentiment towards gold, as investors become more confident in the global economy and put their money into riskier assets such as equities. Prices have slid 12 per cent since October to less than $1,580 (U.S.) an ounce, and are down 18 per cent from their record nominal high in 2011.

But the shift to selling by ETF investors is a concern in its own right for the gold market.

"The acceleration in gold ETF outflows is worrying," says Joni Teves, precious metals strategist at UBS. Suki Cooper, analyst at Barclays in New York, describes a continuation of the current selling trend as "the key downside risk for prices."

The reason is that ETFs have become a major presence in the physical gold markets.

Since the first gold ETF was launched in Australia in 2003, the products have become enormously successful. The funds offer investors a relatively low cost and easily tradable way to access physical gold by holding gold in a trust, which then issues shares that can be traded on an exchange.

With some 2,491 tonnes of gold held around the world, collective ETF holdings outnumber all but two central banks: the U.S. and Germany. ETFs hold enough gold single-handedly to supply the jewellery market in India – the world's largest consumer of the metal – for more than four years.

The sell-off in ETFs is also causing consternation because it has come as a surprise. In previous periods of gold price weakness, ETF investors have stuck with the metal. In the last two months of 2011, for example, gold prices dropped 13 per cent, but ETF holdings increased.

In the past two months, however, ETF holdings have fallen in tandem with prices. While the drop is small relative to the total holdings in gold ETFs, it is still the largest sell-off on record.

"It's a little worrying," says a fund manager with large investments in gold. "This has never really happened before."

Goldman Sachs said in a recent report that the past month's sell-off had caused it to re-evaluate its predictions about how gold ETF investors would behave.

Typically, analysts have assumed that ETFs are held by institutions such as pension funds or insurance companies that have decided to allocate a proportion of their assets to gold. In the U.S., gold ETFs are also popular with individual investors. Neither group, it was assumed, would rush to sell at the first sign of trouble.

"The latest collapse in gold ETF holdings stands in sharp contrast to our assumption that ETF positions were likely driven by longer-term allocation rather than short-term trading," wrote Damien Courvalin, analyst at the bank, arguing that a continuation of the decline in holdings would "precipitate and accelerate" a fall in prices.

Goldman – as did Credit Suisse and Société Générale – recently declared that the gold bull market has ended.

Not everyone believes the ETF sell-off represents a sea-change in investor attitudes, however.

Nicholas Brooks, head of research at ETF Securities, which launched the world's first physical gold ETF, says that gold ETFs have become popular with shorter-term traders as well as long-term investors. "There are still very strong core holders of gold ETPs [exchange-traded products] as a hedge against currency debasement and potentially unexpected inflation. Those guys are still there and they're holding on."

Indeed, some traders and investors believe that the sell-off simply reflects the activity of a few large hedge funds selling down their gold investments.

"There's a lot of different uses for ETPs [exchange-traded products]," says Dodd Kittsley, head of ETP research, at BlackRock iShares, another provider. "The sell-off in gold ETPs is certainly more dominated by the tactical type of investors."

"In my conversations with hedge funds, I don't sense that anybody thinks we've entered a bear market," agrees James Steel, precious metals strategist at HSBC. "I do think that many of the medium- and short-term traders think that right now gold is not doing very well and a few other things are quite tempting."

That view is backed up by data on the futures and options markets, where hedge funds are typically more active. Bets on falling prices on the Comex exchange have risen to their highest level in more than a decade, according to the Commodity Futures Trading Commission.

Marcus Grubb, managing director for investment at the World Gold Council, which sponsors the world's largest gold ETF, draws a parallel with the first quarter of 2011, when there were significant, though smaller, redemptions in gold ETFs as some investors were predicting a rebound in growth.

"We're at a pivotal point," he says, noting that in 2011 gold surged higher as bullishness about the global economy faded. "It depends on what happens from here: that's the test."