15 July 2010

GLD contango strategy, or not?

A reader asked me to comment on A GLD contango strategy by Izabella Kaminska. It talks about Paulson & Co earning a return on its $3.4bn woth of GLD shares.

Holding GLD, meanwhile, is cheaper and more cost efficient than buying bullion outright.

I would note that most gold ETFs have management fees around 0.4%. Considering that Bullion Vault's storage fee is 0.12% and that Paulson would likely be able to get better rates than that from a bullion bank on $3.4bn worth of gold, it would be clear that GLD is not cheaper.

is it actually beginning to vacuum the world’s known gold supply float? Gold supplies, which previously, we might add, would have been put to work by central banks and bullion banks that owned them.

If you look at all ETFs and other storage services for which we have public numbers, together they only total 6.5% of all privately held gold. On top of that you can add the 30,000 or so tonnes of central bank gold. GLD is hardly vacuuming "known gold supply float".

Given the low costs associated with holding GLD versus pure bullion, as well as the permanent contango in the market — it is quite clear the asset lends itself favourably to the ever popular contango storage strategy

Because GLD is at least 4 times more expensive to hold than an allocated account for someone of Paulson's size, I'm not sure he could out arbitrage other players.

you buy GLD (perfect proxy for gold, but with no storage costs) you create a hedge by selling front month gold futures. You then lock in the spread further down the curve, and sit and collect the contango premium.

Firstly, GLD does have "storage costs", that is the 0.4% management fee. The problem with the strategy she proposes is that by selling a futures contract she has hedged the GLD long position. So while you may earn the contango, you won't make any money on the increase in the gold price because if the gold price increases, then you are losing on your short futures contract.

She has confused trading the basis (gap between spot and futures) with trading the price. You are either doing one or the other, but can't do both at the same time with the same capital.


  1. The thing is you can lend GLD and earn a stock lending interest on that, which is apparently much higher than the lease rate.. That will cover cost of management fees more than enough.

  2. Thanks for the post, Bron (I was the anono-mouse who linked that FT story).

    I suppose a delta-neutral strategy makes sense during the summer, when sustained price moves higher have not tended to happen since the start of the current bull.

  3. Interesting about lending GLD. Question is though why would you want to borrow GLD to short gold when you can borrow physical at lower lease rates?

    Probably only something for failed settlements or retail investors to do. I wonder how much demand there would be for borrowing GLD.

  4. The shorting business in some etfs is bigger than the long business. Hedge funds for example will only start using etfs that can easily be shorted for long short strategies etc. It's just another part of the stock lending business. Have a look at the short interest in gld on bloomberg and you will see how common it is. Also high frequency traders will hedge with shorts through the day to capture arbitrage.

  5. For any sizable player I would have thought that long/short strategies more cost effective via futures rather than ETF, unless unwilling/unable to trade futures.

    If the market makers are able to supply short shares at share lending rates that is real cream on top of their existing profits arbitraging ETFs to spot prices.