08 August 2013

Gold Daily and Silver Weekly Charts - GLD May Be In the Eye of the Gathering Storm

I spent some time rereading the prospectus and some recent filings of the SPDR Gold ETF today. 

A reader had asked me a question this morning about a statement I made yesterday about the squeeze on physical bullion and how it may intensify if gold rallies. I said that GLD has to start adding back some of the bullion it has disgorged at some point, and many of those 400 oz. bars may likely have headed east, not to return.

The reader said, 'why can't GLD just refuse to add the gold back?'

It is not the management of GLD's decision to make. I had to go back and read the prospectus and some recent filings to remind myself why.

GLD essentially acts as a trustee, with very light obligations and therefore a small management fee. It is primarily an organizer for the bullion banks and other brokers, who as 'Authorized Participants' make the decision to increase or decrease the amount of gold held in the GLD ETF and the number of unit shares outstanding.

The current Authorized Participants according to GLD's most recent filing are Barclays Capital Inc., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., Goldman, Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., J.P. Morgan Securities Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. Incorporated, Newedge USA LLC, RBC Capital Markets Corporation, Scotia Capital (USA) Inc., UBS Securities LLC, Virtu Financial Capital Markets, LLC and Virtu Financial BD LLC.

GLD is a creature based largely on arbitrage and self-regulation of a variety of market participants and custodians. HSBC acts as primary custodian for the gold in their allocated and unallocated accounts. An Authorized Participants can add or redeem gold from the holdings of GLD in 100,000 unit tranches.

Although it can be confusing, I sometimes refer to 'GLD' as the collective action of the Authorized Participants in arbitraging the price and inventory. And I am not the only one.  I know its sloppy, but that's what it is. Earlier this year a spokesperson  for GLD itself made the same type of statement about their intention with regard to share/bullion ratios, and I quoted it indirectly.

But it is correct to say that this is a 'group thing' based on market equilibrium, arbitrage, and counterparty trust.  I am sure they do not have to meet about or discuss it, because in theory the information is all conveyed by the market and their access to real time inventory data.  I do not think all this information is shared equally among market participants.  There is an 'intraday indicative value' with the symbol PHYS.IV.

The Authorized Participants have the ability to sell the units short, although they could achieve a similar equilibrium by shorting or buying in an associated market like the COMEX or the derivatives market for example.

It is this function that provides the lever for the arbitrage. If retail demand pushes the price of GLD above its Net Asset Value based on its bullion and units, the Participants who know this figure intraday can sell shares short to match it to the price of gold and buy bullion if they wish as a hedge. Or tweak the spot price in the futures market by performing essentially the same buy and sell functions.

If they wish to cover these shorts, they may deposit a 100,000 unit tranche of gold back into the ETF and use those shares received in return to cover the short. Or they may buy back in the open market if the price has dropped below the NAV. If they wish to reduce the amount of gold in the GLD account they can redeem units in 100,000 unit tranches.

Off hand I could not say if the ETF unit shorts are borrows or naked.  I suppose it is like anything else these days.

I know this is a simplification, and there is an interesting dynamic going on since these same Authorized Participants are sometimes 'major players' in the COMEX where the price of spot is essentially set intraday, in addition to the LBMA twice daily price fixes.

If you wish to read this further here is a link to the GLD filings. Some web sites such as VictortheCleaner also provides further commentary, although I might not call GLD the central bank of the bullion banks because of GLD's structural passivity.

In reviewing things, I have come to a tentative conclusion that if this system of balancing risks should fail, a counterparty failure is more likely to occur first with GLD rather than in the COMEX or LBMA, although this might be a matter of a same day occurrence.

So if the price of gold starts going higher, and the shorts cover in the open market, they have little other choice in their arbitrage than to buy gold eventually and add units to the ETF to bring the NAV back into equilibrium with price.

Where they may find the suitable 400 oz. bars to do that is another question altogether. And the fiduciary responsibility for GLD is spread across a range of participating custodians, subcontractors and brokers.

Weighed, and found wanting.

Stand and deliver.