29 January 2011

Funny business in GLD

FOFOA has an interesting speculation on the movements in GLD:

So now I offer up a scenario, not as a statement of fact, but as fodder for thought and discussion. In this scenario I am not assuming that the drain on GLD to date has been the direct redemption of ETF shares by Giants. I presume it is simply redemptions by Bullion Banks in order to meet the delivery demands of "important clients," real Giants, perhaps from Asia and the Middle East. And because the BBs would normally have better options than plundering GLD, I am assuming those options are either gone or far more problematic than legalized looting.

Also, following Lance Lewis' "puke indicator," one could be forgiven for suspecting that the Bullion Banks have some way to temporarily "pound" the price of gold down on the COMEX in order to buy back ETF shares during a "good price window" with the intention of redeeming those shares into deliverable gold for clients that purchased it at a higher price.

I left a comment, which I post below FYI:

The reason one cannot correlate gold price and GLD holdings is because authorized participants (AP) don't have to create and redeem GLD shares on a daily basis in response to investor activity in GLD.

For example, if you're an AP and have a view that the market is bullish, then you expect over time to see net buying of GLD. Therefore, if on one day there is net selling of GLD, then you can:

1. Buy GLD shares
2. Immediately lease gold and sell it (or just short futures).
3. AP is now long GLD and short unallocated gold or futures. Important to note they have no exposure to gold price movements.
4. Sit on the GLD shares and when investor bullish sentiment returns
5. Sell your GLD shares
6. Buy unallocated gold and repay your lease (or close out your short future).

The above process means that the AP avoids GLD share redemption and creation costs.

Same thing happens in the face of net buying - an AP borrows gold and delivers it to GLD for shares, which they sit on an over a period of time sell into demand for GLD.

This is a way of minimising transaction costs when making a market in GLD or SLV or any other ETF.

The end result is that we see lumpy creation and redemptions, reflecting accumulated buying or selling activity over a number of days.

In the case of large lumpy redemptions, that can reflect an AP who held on to GLD shares in the expectation they would be able to offload them later into expected buying. If that buying does not eventuate, then the AP offloads the lump of GLD share they have as they are incurring ongoing funding costs.

You are correct in that redemptions of GLD cannot really be used to infer too much about what is going on re investor sentiment. The GLD bought back by an AP and gold redeemed is just sold by the AP to someone else, ultimately.

All GLD holding movements tell us is the sentiment of GLD holders. All that futures tell us is the sentiment of futures traders. Are these markets representative of the all private investors in gold. Maybe, maybe not.

What commentators miss is the OTC "dark pool". Consider that ETFs + Futures only represent less than 10% of estimate privately held gold (see this post).

In that case, we should not get too excited by the activity we see with ETFs and futures as it is not where the real giants are.

Consider also that bullion banks know their activities in ETFs and futures can be seen/deduced in some way. Therefore you must assume they let you see what they want you to see, with their real position and activities hidden in the "dark" OTC market.

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