When Your Precious Metals Blogger Doesn’t Understand How ETFs Work…

One cannot speak intelligently about the metals markets these days when one does not understand how exchange traded funds work.  $GLD for gold and $SLV for silver became massive players in their respective markets, with GLD  becoming the largest ETF in the world for a brief period.

So when your friendly neighborhood metals blogger writes stuff that demonstrates a gross misunderstanding of how these ETFs operate, it should be of no surprise that they arrive at erroneous conclusions when forming theses about the precious metals markets or trying to explain price action.   One cannot hope to accurately evaluate the precious metals if one doesn’t have a grasp of the workings of GLD, SLV, PHYS, PSLV, CEF, and the other exchange traded funds and closed end funds in the market.

For a primer, please read my prior three posts on this subject where I explained the creation/redemption procedure in depth:

ETF lesson Part I

No, GLD is not Overdue to Buy 200 Tons of Gold – An ETF Lesson Part II

Why is GLD So Hard For People to Understand – An ETF Lesson Part III

Today, as part of my charitable public service, I will address a few misunderstanding from a purported precious metals “expert” who frequently demonstrates that he doesn’t understand the ETFs, and today made some gross errors.

“Jesse” writes:

“And the policy of GLD is not to smooth their inventory using hedging, but to maintain their inventory roughly 1 to 1 of allocated gold with respect to tracking the gold price.  So, it seems very likely that GLD was selling a lot of bullion in London and it is LBMA ready.”

GLD doesn’t have to smooth their inventory or hedge anything – they hold allocated gold bars as the asset backing the outstanding shares of the Trust.  What would there be to smooth or hedge?  And no – GLD wasn’t selling a lot of bullion – GLD doesn’t buy or sell bullion.  Authorized participants buy and sell bullion in response to GLD flows to arbitrage differences between GLD and its net asset value (the value of the bars that the trust holds).  I described this process in detail in the prior posts. Let’s do a self copy & paste of my prior explanation of this topic:

“If “the market” is lacking GLD sellers, and the price of GLD rises so that it is in excess of it’s NAV (net asset value)  there are arbitrageurs standing by ready to short you shares of GLD while they simultaneously buy gold bullion as a hedge.  Since they are selling GLD “rich” to its fair value, they will make a profit when they eventually collapse their position.  How do they collapse it?  Well, they take their gold and “create” GLD by delivering the gold to the trust, receive newly created GLD and use that to cover their GLD short position.  Voila – they’re now flat, and the GLD’s assets have increased, as have the shares outstanding. 

Of course, recently, we’ve seen the opposite: excess supply of GLD shares.  It works both ways!   As GLD supply results in the shares trading slightly below their NAV, APs buy the shares, sell gold in other venues, then redeem their GLD shares (turn them in to the Trust in exchange for gold – we can talk about the details of how they do this via de-allocation of GLD’s bars, and credits to unallocated accounts, if you really want), and use the gold to cover their short position.   GLD and SLV were each instrumental to bringing their respective metal to the masses.   That was great for prices when everyone wanted to buy, but you can see the resulting effect when everyone wants to sell.

Let’s see what else Jesse screwed up:

“I just don’t know exactly how much GLD has, and whether it is 1 to 1 or not.  I don’t think there are any auditor reports that I can go to and look at their allocated inventory bar for bar, and say, “This is exactly how much they have.”   But I am sure they do have some amount. “

Yeah, if only there was a bar list that listed every single allocated London Good Delivery Bar that GLD owned… And if only there was an auditor report that verified the holdings… That, you see, was sarcasm, because both of those items are readily available online.   In fact, GLD and SLV are much more transparent than their closed end trust counterparts offered by Sprott Inc.

Finally:

“I find it hard to imagine how they maintain their ratios in such volatility without resorting to hedges and leasing.  But they say that they do. “

Maintain WHAT ratios?  When the price of gold moves, GLD doesn’t have to maintain any ratio.   They own gold, the value of the gold goes down, and the value of the shares goes down.  When the price of gold goes back up, the value of the gold in GLD’s vault goes up, and the price of the shares goes up.   “Hedging” and “leasing” have no place here.

Just because one does not understand something does not mean that thing is fraudulent, problematic, or conspiratorial.

It is important for precious metals blog readers to take note, however, of authors who demonstrate a serious lack of understanding of the products that have significant impact in the market they are trying to analyze.

related:

ETF lesson Part I

No, GLD is not Overdue to Buy 200 Tons of Gold – An ETF Lesson Part II

Why is GLD So Hard For People to Understand – An ETF Lesson Part III

Facts: The Enemy of the Precious Metals Blogger

-KD

postscript: I sincerely wish Jesse the best of luck with any personal or health issues he is dealing with.  He made a reference in his post to some “troubles.”   My intention in this post is simply to correct the misunderstandings of yet another precious metals blogger of prominence, so that these misunderstandings do not spread too rapidly.

postscript 2:  the purpose of the post is not to attempt to explain why the metals have seen their prices annihilated over the past few weeks, although I will offer a guess as to what happened:  gold and silver, over the last 10 years, morphed from “flight to safety” assets to “asset allocation” assets which became a part of many portfolios and trading positions,  as well as a hot money hedge fund trade.  As I alluded to earlier in this post, that’s great for prices when sentiment is good, and terrible for prices when sentiment turns.

disclosure: I have a spread trade on right now to take advantage of $CEF ‘s discount to NAV: I am long CEF, and short the proper ratios of $GLD and $SLV against it, betting that CEF’s discount to NAV will shrink.  My position size today is half as big as it was yesterday.  The risk for me is that CEF cannot be redeemed, so the discount can’t be forcefully closed by arbitrageurs.    Sprott’s $PSLV and $PHYS funds do have redemption features, but they are still trading slightly cheap to NAV due to fees associated with the redemption process.  PSLV, PHYS, and CEF all lack a “creation” feature where participant can deliver metal to the Trust in exchange for new shares.

I am not bearish on either gold or silver – I’m bearish on misinformation in the gold and silver space, and I will continue to donate my time correcting such misinformation.

Alternatively, there’s always my Confirmation Bias Service, which is NOT going like gangbusters.

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