24 August 2010

GLD, leasing and encumbrances

In an otherwise good analysis of GLD (Precious Metals ETF Alchemy
GLD – the new CDO in disguise?
) and building on Catherine Fitts’ Precious Metals Puzzle Palace Hinde Capital (as does Ms Fitts) gets it wrong on leasing (see slide 18). A bit of a problem considering that "GLD has encumbered gold in it" is one of his key points.

In my experience most lease transactions are done in terms of unallocated account credits. In this case the lender has lent unallocated and if the Authorized Participant subsequently allocates this unallocated metal there is no direct link between the loan and the physical. The lender has an unsecured exposure to the Authorized Participant under the terms of the original lease. There is simply no legal link to what the Authorized Participant did with that leased unallocated gold.

In the case of lenders supplying actual physical bars (usually only be Central Banks) because it is understood that leased metal will be "used" (be that in a physical operation like a jeweller or mint, or for sale to create a short position), the contract cannot practically require the return of the same physical bars that were lent (ie the same bar numbers). If the lease contract was worded on a secured basis (most likely where the borrower is a jeweller or mint) the security would have to be against the general gold stocks of the borrower rather than the bars originally supplied as it is understood that the original bars are melted or sold.

Where lease contracts specify the return of physical at the end of the lease, it is acceptable to settle with any LBMA bar at maturity, with any ounce difference (due to the variability of 400oz bars) settled via cash.

As a result, there is no legal claim by the lender on the original physical bars supplied to the borrower. Therefore if an Authorised Participant borrowed physical and delivered that to GLD, there would be no claim or encumbrance by the lender to the Authorised Participant on those bars held by GLD.

I note that Hinde Capital avoids the “they don’t have the gold” claim. That is an issue I will post on another time.


  1. He also says that gold has 'no utility'.

    Not a great record.

  2. do you know if the asx gold is in the same category as gld in US? I tend to buy the perth mint version on asx as I view it as safer

  3. See my comments at http://goldchat.blogspot.com/2008/12/warning-on-existing-au-and-new-ag-pt-pd.html

  4. David Morgan and ZeroHedge getting it wrong on this issue http://kiddynamitesworld.com/today-in-silver-misinformation-david-morgan-swaplease-edition/

  5. There is one update I have to make to statement “Therefore if an Authorised Participant borrowed physical and delivered that to GLD, there would be no claim or encumbrance by the lender to the Authorised Participant on those bars held by GLD” which is after reading the prospectus in detail in reply to a comment by Victor I found that the APs can only deliver unallocated to the custodian, so my sentence is not correct. It is only the custodian who could possibly leased in specific physical bars and then allocate them to an ETF.

    I really doubt that anyone in the PM market lends specific bar numbers as I say in my article, but if that was the case it may only be a problem if the lending agreement made reference to the fact that the lender retains title to the bars (which can be specifically identified by bar number) and in that case the BB then allocating them to the ETF has given the ETF bars to which the BB does not have good title, so it would be defrauding the ETF.

    It is a possibility but so remote as I can’t see why any BB would accept such lending terms – they are too smart for that. And any lender insisting on such terms would be laughed at with the comment – “do you think we want to lease these bars just to look at them and then return the same bars back to you”?.