Funny business in GLD

FOFOA has an interesting speculation on the movements in GLD:

So now I offer up a scenario, not as a statement of fact, but as fodder for thought and discussion. In this scenario I am not assuming that the drain on GLD to date has been the direct redemption of ETF shares by Giants. I presume it is simply redemptions by Bullion Banks in order to meet the delivery demands of “important clients,” real Giants, perhaps from Asia and the Middle East. And because the BBs would normally have better options than plundering GLD, I am assuming those options are either gone or far more problematic than legalized looting.

Also, following Lance Lewis’ “puke indicator,” one could be forgiven for suspecting that the Bullion Banks have some way to temporarily “pound” the price of gold down on the COMEX in order to buy back ETF shares during a “good price window” with the intention of redeeming those shares into deliverable gold for clients that purchased it at a higher price.

I left a comment, which I post below FYI:
The reason one cannot correlate gold price and GLD holdings is because authorized participants (AP) don’t have to create and redeem GLD shares on a daily basis in response to investor activity in GLD.
For example, if you’re an AP and have a view that the market is bullish, then you expect over time to see net buying of GLD. Therefore, if on one day there is net selling of GLD, then you can:
1. Buy GLD shares
2. Immediately lease gold and sell it (or just short futures).
3. AP is now long GLD and short unallocated gold or futures. Important to note they have no exposure to gold price movements.
4. Sit on the GLD shares and when investor bullish sentiment returns
5. Sell your GLD shares
6. Buy unallocated gold and repay your lease (or close out your short future).
The above process means that the AP avoids GLD share redemption and creation costs.
Same thing happens in the face of net buying – an AP borrows gold and delivers it to GLD for shares, which they sit on an over a period of time sell into demand for GLD.
This is a way of minimising transaction costs when making a market in GLD or SLV or any other ETF.
The end result is that we see lumpy creation and redemptions, reflecting accumulated buying or selling activity over a number of days.
In the case of large lumpy redemptions, that can reflect an AP who held on to GLD shares in the expectation they would be able to offload them later into expected buying. If that buying does not eventuate, then the AP offloads the lump of GLD share they have as they are incurring ongoing funding costs.
You are correct in that redemptions of GLD cannot really be used to infer too much about what is going on re investor sentiment. The GLD bought back by an AP and gold redeemed is just sold by the AP to someone else, ultimately.
All GLD holding movements tell us is the sentiment of GLD holders. All that futures tell us is the sentiment of futures traders. Are these markets representative of the all private investors in gold. Maybe, maybe not.
What commentators miss is the OTC “dark pool”. Consider that ETFs + Futures only represent less than 10% of estimate privately held gold (see this post).
In that case, we should not get too excited by the activity we see with ETFs and futures as it is not where the real giants are.
Consider also that bullion banks know their activities in ETFs and futures can be seen/deduced in some way. Therefore you must assume they let you see what they want you to see, with their real position and activities hidden in the “dark” OTC market.

Globalisation: the glass is half empty

One of the many fascinating facts that you see in Economic History and Modern India: Redefining the Link by Tirthankar Roy (Journal of Economic Perspectives, Summer 2002) is about India’s trade/GDP ratio. The trade/GDP ratio rose dramatically from 1 to 2 per cent in 1800 to 20 per cent in 1914.

By 1970, the trade/GDP ratio had dropped to 8 per cent. It was only in the mid 1990s, the trade/GDP ratio had got back to
the 20 per cent value seen in 1914.

Most people in India today are not aware of the pre-War world, where goods and services flowed freely across the boundary, when
people in India diversified their portfolios across the globe, travelled freely within the British Empire, etc.

After the War, there was a big push worldwide to reduce trade barriers. Governments, then, made the call that agriculture was not
worth fighting for (since it was a fading share of world GDP but a large number of votes), and focused on manufacturing. By and large,
this worked. Trade in manufacturing is pretty free worldwide.

But world GDP shifted away from manufacturing. Today, world GDP is dominated by services. World GDP is now 5.8% agriculture, 30.8% manufacturing and 63.4% services.

Crudely speaking, if we have full free trade in goods, but zero trade in agriculture or services, then 69% of World GDP is submerged
in autarky.

Over the last 20 years, manufacturing trade liberalisation has continued, but the share of services in world GDP has risen. I suspect
that overall, this has made the world less hospitable to trade.

An interesting article on voxEU by Sebastien Miroudot, Jehan Sauvage and Ben Shepherd points out that in the aggregate, the costs of trade have dropped sharply for goods from 1995 onwards, but not for services.

We need to work harder on removing a variety of barriers to trade in goods. But we need to work much harder on removing the barriers to trade in services.

In this sense, the globalisation project is far from done. By and large, the world has done well on removing barriers to the movement of goods and capital (though India is as yet a laggard on both fronts). The two great frontiers are now trade in services and the movement of people. Given the huge footprint of services in world GDP, it is not even the case that we are exposing the world economy to as much global competition as was the case a few decades ago, when manufacturing was a big part of world trade and there was a lot of trade in it.

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Economic Events on January 31, 2011

At 8:30 AM EST, the monthly Personal Income and Outlays report for December will be released.  The consensus for Personal Income is an increase of 0.4% over the previous month and the consensus Consumer Spending index change is an increase of 0.5%.

At 9:45 AM EST, the Chicago PMI Index for January will be announced.  The consensus index value is 65, which is 3.6 points lower than last month, but is still well above the break-even level at 50.

At 3:00 PM EST, the Farm Prices report for December will be released, giving investors and economists an indication of the direction of food prices in the coming months.

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