Thursday, July 16, 2009

Getting in Front of It - GLD

One group of people that's even more fanatical than the Goldman Sachs conspiracy theorists are the Goldbugs. As I read David Einhorn's (Greenlight Capital) quarterly letter last night, one thing jumped out at me:

"We made a couple of modest changes to our macro hedges. First, after extensive investigation, we switched our entire GLD exchange traded fund position into physical gold. At a minimum this will provide some savings as the costs of storing gold are less than the fees on GLD."

Now, I happen to believe in GLD as a product. I have read the prospectus multiple times, which states that the GLD owns physical gold bullion - not gold futures or other paper versions of gold. GLD shares can actually be redeemed for physical gold bullion (if you have enough shares). This doesn't stop the Goldbugs from trumpeting about how the GLD is NOT the same as gold, and that if you really want to own gold, you should buy bullion instead. Well, GLD is not gold - it's a share in a trust that owns gold, but the difference is that I actually believe that the trust owns the gold, while some Goldbugs think the whole thing is a giant scam.

Anyway, I'm CERTAIN that in the coming days, you'll be able to find some rantings about how Einhorn's "extensive investigation" which resulted in him swapping out of GLD and into bullion is evidence that there are problems with GLD. Look - I cannot guarantee to you that the GLD is a perfect product - I have not seen and audited the gold in their vault (although I am close to someone who works intimately with the GLD trust, and who offered me exactly such an opportunity, should I make it to London in the near future). However, Einhorn explained one reason for the switch - cost. He's got a sizable position, and the means to store physical gold, so he holds the cheaper version.

Also, I could interpret this as a validation of GLD. Although I don't know how Einhorn swapped his GLD for physical bullion - I'd be willing to bet he simple "redeemed" the GLD shares he had with the trust, and took delivery of gold bullion. This is great news for those who fear that the GLD is a paper pyramid - that Einhorn was able to do exactly what he was supposed to do - that GLD and gold are essentially fungible. Again, I can't be sure that's what Einhorn did, and if anyone has any evidence or inkling that he actually sold his GLD position and bought physical bullion, I'd LOVE to hear about it, as that would nullify my whole point.

We could also draw the conclusion that perhaps Einhorn plans to hold this position for a longer period of time - although, since GLD and gold are fungible, he could easily liquidate his position by shorting GLD and creating shares of the ETF with the trust to close out his position - relax, it's not as confusing as it sounds - you can take your GLD and give them to the trust in exchange for gold bars, or you can take your gold bars (redeem) and give them to the trust in exchange for GLD (create). In other words, the GLD is just a more liquid way for the average person (or the professional hedge fund manager) to trade gold.


full disclosure: long GLD and SLV

and note to Goldbugs: PLEASE do not leave me comments saying that the GLD is fraudulent because it can be shorted - it's a false logic argument, and it's incorrect.


Anonymous said...

Kid could you explain the high IRR numbers on the quarterly letter? Im assuming they are internal rate of return, but they dont correspond with the ave entry and exit.

Kid Dynamite said...

yes - they are ANNUALIZED internal rate of return... so Einhorn may make $1 on a $100 stock, but if his holding period was a few weeks, his IRR is much higher than 1%

matt said...

I think that GD typically releases figures on redemptions. We could just wait until this is reported and see if there is a spike in redemptions, right?

Anonymous said...

gotcha. thx. not sure i like his use of that metric as it doesnt really quantify a trade as well as simply stating the return on the trade in my opinion. thanks again.

Kid Dynamite said...

well, it is important to standardize... after all, a trade that earns 10% in a month is clearly better than a trade that earns 10% in a year.... the problem is that you can't necessarily reproduce the 1 month trade 12 times in a year, but it's still good for measurement. this is relatively standard - especially in the merger arbitrage community - it's how you compare the relative risk being price into deals - you annualize it.