However, when I read something that I know is blatantly false in a paper with as much clout as the Wall Street Journal, it bugs me. WSJ reporter John Jannarone wrote an article on the GLD trust on Sunday that fundamentally misunderstands how the trust works, and since he's not the only one (I read some "GLD IS A SCAM!" articles which posed similar questions), I felt the need to explain it here.
First, let's review his claims:
"ETFs such as SPDR Gold Shares -- ticker GLD -- are a direct bet on bullion prices. The trusts have to buy physical gold to match investment levels. Having doubled the gold in their vaults in a year, the stash is worth $45 billion.That's tiny in the context of big asset classes like stocks. But gold's scarcity keeps the market small. If ETFs continue to grow fast, they could start to create a real squeeze in gold, with its limited supply."
and then in his conclusion:
"If, and when, investors decide the game is up, ETFs will have to liquidate holdings as people sell. Just as they are squeezing the market now, they could flood it when the frenzy ends."
OK - Mr. Jannarone has one thing right that a lot of people fail to understand - GLD is indeed a direct bet on bullion prices - they own gold bullion, not futures or options. You can read all about the details of the GLD Trust here.
Now, you are able to create shares of GLD (in 100,000 share increments) if you go out and buy the corresponding amount of gold bullion. You can take your bullion, deliver it to the trust, and get shares - but the trust doesn't have to go out and buy any bullion. Similarly, if you have 100k shares of GLD, you can give them back to the trust (aka, "Redeem") and they will give you gold bullion in return.
The reason the shares outstanding of the GLD are increasing is because someone is creating GLD shares. Even though GLD frequently trades very close to its net asset value, (you can get the data here) I'd guess that someone has been shorting GLD when it trades rich (above NAV), and buying bullion. This arbitrageur then takes his bullion and delivers it to the trust, and received GLD shares to cover his short.
There has been a lot of talk lately about the USO Oil ETF, and its impact on the oil market. The USO is structured differently from the GLD in that it owns oil FUTURES, which must be rolled each month. The assets of the USO are a huge percentage of the outstanding open interest in oil futures, and thus it ends up costing the trust a great deal each month when they roll their futures position, because everyone in the market knows they are coming and rips their eyes out. GLD, on the other hand, doesn't have to roll anything - they just hold their gold bullion in their vault.
This is neither a recommendation to buy or sell GLD - just an attempt to correct a common misunderstanding out there in the market.
Thus concludes today's lesson.