 streetTRACKS
Gold Trust - A Midas Touch
Y. T. Wong
Hong Kong
13 December, 2004
This essay tries to dispel the following misconceptions for the
benefit of gold investors.
[1] Duplicate numbers on gold
bars.
[2] Physical locations of the gold bars are dubious.
[3] Physical gold holdings do not exactly match stated ounces
of the Trust.
[4] GLD is anti-Gold.
[5] "Proprietary trading" by WGC is harmful to the
gold market.
Out of genuine concern about
the quality of GLD ETF, a few professionals have cast doubt on
GLD as a safe investment instrument and warned investors to be
careful before buying GLD. It is a pity that these misconceptions
cannot be immediately clarified by the World Gold Council because
WGC is forbidden by SEC to respond to baseless charges. WGC's
silence is government mandated.
We need to understand the modus
operandi of GLD ETF trading before we can assess its usefulness.
I assume I am the Chief
Gold Dealer in New York to run GLD ETF.
On day 1, at the start of the
trading day, I am (supposedly) "squared" - neither
long of physical gold or short of gold. As soon as market opens,
the Trust sells (investors buy) 4,000 ounces of gold at US$440
per ounce (400 contracts - each contract comprises 10 ounces
of gold). Now I am short of 4,000 ounces of gold at US$440 per
ounce. I must cover my short position by buying the gold. I have
several options:
Option No. 1
I buy 4,000 ounces of gold on the Comex futures market.
Option No. 2
I buy from a loco London gold dealer (spot gold dealer) who is
quoting $439.80 - $440.20 (i.e. I buy at US$440.20).
Option No. 3
I do nothing, and wait for the market to come down and buy (perhaps)
at a cheaper price. This means I run a speculative short position.
Option No. 4
Before the sale of GLD ETF, I have anticipated the up-trend of
the gold market and have already bought 4,000 ounces of spot
gold at a lower price, to sell to the investors of GLD ETF at
US$440 per ounce.
Option No. 5
I am also a spot gold dealer. Since I am short of gold, I can
afford to quote a slightly higher price at $439.90 - $440.30,
which is more attractive to sellers of spot gold. These sellers
give me gold at $439.90 instead of selling to other gold dealer
at $439.80.
To me Option No. 1 is out of
question because if I execute the Comex trade after the sale
of GLD, more often than not Comex gold prices move against me.
Besides Comex gold is not a physical market.
Option No. 2 means I lose money
on every trade because I suffer the dealing spread of 40 cents
per ounce.
The choices left to me are
Option Nos. 3, 4 and 5. To run the dealing room efficiently and
profitably, I must be pro-active and do the so-called "proprietary
trading" in the spot gold market (I often take long or short
positions, within internal limits, during the course of the day
-- not "squared" as understood by some professional
writers). My gain or loss in proprietary trading does not affect
the assets of GLD ETF. My trading provides liquidity to GLD,
nothing else. At the end of the day or at the end of the week,
I must provide sufficient physical gold bars at HSBC bank vaults
to back up the outstanding long GLD contracts. As long as there
are sufficient gold bars at the HSBC bank vaults, on "allocated
accounts," the GLD investors should rest assured
they in effect possess physical gold, though the holding is through
an indirect method in share certificates. As to the gain or loss
of my proprietary trading, it is none of the GLD investors' business.
The launch of GLD is a great
success. It is a gold dealer's dream to have so many buyers'
and sellers' orders placed at his fingertips, so I can trade
profitably, very profitably. Having large firm orders at my disposal,
I am in a unique position to anticipate market movements to buy
or sell gold beforehand. In addition, I can quote better dealing
prices (narrower bid and offer spreads) than other gold dealers.
Because of my better spot gold quotations, more gold producers
come to me for business. Central banks also come to me for trading.
Success breeds success. The result is that WGC makes tons of
money (thanks to the Midas Touch in creating GLD ETF).
I now address the misconceptions:
[1] Duplicate numbers on
gold bars.
Johnson Matthey has clarified
the matter.
[2] Physical locations of
the gold bars are dubious.
Either you trust HSBC or you do not trust HSBC. If you do not
trust HSBC, you should buy physical gold and find a place (a
safer place than the vault of HSBC) to store your gold bars.
It appears investors and some
commentators do not understand the meaning of "Allocated
Gold Account," GLD's bars are on Allocated Accounts,
and you can identify the gold bars by their numbers. HSBC segregates
the gold bars so they do not mix up with the Bank's other assets.
In the event (most unlikely) HSBC goes down, the segregated gold
bars (with identifiable numbers) will not become a part of the
Bank's general assets which are subject to the claims of the
Bank's creditors. To simplify further, these gold bars
with identifiable numbers are in effect stored safely inside
an enormous safe deposit box, locked up by HSBC, and marked outside
the box "Properties of GLD shareholders."
[3] Physical gold holdings
do not exactly match stated ounces of the Trust.
Spot gold dealers trade in bars of 400 ounces. Their dealing
price is normally good for 4,000 ounces (or 10 bars). Settlement
is on spot basis, i.e. 2 trading days after conclusion of the
transaction. On settlement date, ownerships of gold bars are
transferred from one account to the other (ledger entries). Only
when ledger balance of gold bars reaches a certain high level
then physical gold bars are moved from one location to the other.
When gold ledger balance is small, there is no physical gold
movement to save delivery and administrative costs. GLD investors
need not be worried about gold bars not in the vault of HSBC
because WGC undertakes to (and they do) place physical gold bars
at the vault of HSBC to match the holdings of the Trust. Should
there be something wrong with gold bars not inside HSBC vault,
it is the problem of WGC, nothing to adversely affect GLD investors.
The weight of each gold bar
is approximately 400 ounces. The gold fineness is 995+ (purity
of 99.5% or higher). We can have a gold bar weighing 402.67 ounces
with fineness of 996. Since the gold we trade is pure gold, this
gold bar is recorded as 402.67 x 99.6% = 401.06 ounces of fine
gold. So you see, the gold bars rarely match exactly the gold
holdings. Difference of several ounces is normal, and investors
need not be unnecessarily alarmed.
[4] GLD is anti-Gold
The allegation is rampant when the Gold Trust on Tuesday 7th
December sold 15 tons of gold (physical holdings down to 88 tons)
and gold prices fell sharply. Some said WGC was rigging the gold
market in conspiracy with the Government.
When the 15 tons were sold,
gold bugs complained. What about the balance of 88 tons? The
short existence of GLD ETF has created a net holding of 88 tons
of physical gold locked away in an HSBC vault. The gold bugs
should applaud the Trust's achievements instead of complaining.
As to market manipulation, the allegation is pointless. Manipulation
is a part and parcel of every financial market. People losing
money in gold trading should not blame others. WGC has discovered
a gold mine through Midas Touch in the form of gold trading to
support GLD. There must be times when they sell short gold in
anticipation of falling prices, but that is being done all the
time by international gold dealers. My thinking is that there
is no need for WGC to speculate by shorting as much as 15 tons
of gold - their extremely profitable intra-day trading precludes
the need to speculate (other than taking open positions within
set trading limits). As explained above, they are in the best
position to offer smooth trading channels to gold producers and
central banks - the 15 tons sold were likely sales from gold
producers and/or central banks. Without GLD ETF, the 15 tons
would have been sold any way, perhaps in a more disorderly fashion
to disrupt the gold market. But it is easy to point an accusing
finger at WGC, a prominent target.
GLD ETF is an efficient instrument,
as evidenced in the smooth sale of the 15 tons of gold. As time
progresses, more and more investors will participate (convenience
to own gold and cheap brokerages), and gold holdings of the Trust
will quickly expand. My conclusion: GLD is Gold Positive.
[5] "Proprietary trading"
by WGC is harmful to the gold market.
Without proprietary trading, it is suicidal for WGC (see Option
Nos. 1 & 2 above) to run a GLD ETF which would never have
been born. Investors want an efficient instrument to buy and
sell gold, and WGC provides it to the investors. Why should investors
(or commentators) envy WGC making profits through proprietary
trading? Why is only WGC blamed and not other gold traders doing
the same thing all the time? If gold trading by WGC is harmful
to the market, ALL gold traders should be banished to an island,
to live with Robinson Crusoe.
WGC has provided a win-win
instrument for itself and for gold investors. Investors should
be grateful.
The writer is not acquainted
with anybody at WGC, nor with anybody inside HSBC connected with
gold custody. The writer is not a financial advisor and does
not give advice nor provide newsletter services.
Y. T. Wong
Contact
Hong Kong
12 December 2004
321gold
Inc
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