Are the underlying mechanics of the largest gold ETF a cause for concern?
Exchange-Traded Funds (ETFs) are an important element in the global gold market. The largest gold ETF is the “SPDR Gold Trust,” which is traded on the New York Stock Exchange Arca (NYSE Arca) under the symbol “GLD.” In this article, we will examine how GLD works to understand its role in the gold market and its impact on the gold price.
Introduction
In general, ETFs are funds that hold and track the price of assets like a commodity or stock market index. But unlike normal funds, ETFs are conveniently traded on stock exchanges. ETF securities represent shares of ownership in the fund. In the case of GLD, shareholders own a segment of the Net Asset Value (NAV) of the fund, which mainly holds physical gold. So, owners of GLD shares don’t own the gold itself, but a slice of the fund. As with other derivatives, GLD provides exposure to the price of the underlying asset.
The stock exchange is referred to as the secondary market. Here, existing shares of an ETF can be traded by all types of investors. In the primary market, ETF shares are created and redeemed by “Participating Dealers.” It’s mainly through the creation and redemption process of shares that the ETF price tracks the price of the associated asset. Let us have a look at how this works with GLD.
The Mechanics Of GLD
Primary market participants for GLD include (from the prospectus dated August 9, 2019):
– The Trustee BNY Mellon Asset Servicing, which is responsible for the day-to-day administration of “the Trust” (the Fund).
– The Custodian HSBC Bank plc (there can be sub-custodians), which stores Good Delivery gold bars for the Trust in London.
– The Sponsor World Gold Trust Services, LLC, a subsidiary of the World Gold Council, which oversees the performance of the Trustee and the Custodian.
– The Authorized Participants, which are the institutions authorized to create and redeem GLD shares at the Trustee. (With other ETFs, these are called the Participating Dealers.) At this moment, the Authorized Participants are Credit Suisse Securities (USA) LLC, Goldman Sachs & Co., Goldman Sachs Execution & Clearing, L.P., HSBC Securities (USA) Inc., J.P. Morgan Securities LLC, Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co. LLC, RBC Capital Markets, LLC, UBS Securities LLC, and Virtu Financial BD LLC.
One GLD share represents 0.1 ounce of gold. (Put differently, the value of one GLD share is equal to the value of 0.1 ounce of gold. And actually, at the time of writing, it’s a little less than 0.1 ounce, for reasons to be explained below.)
The price of GLD is set by supply and demand on the exchange where it’s traded (NYSE Arca), just like the gold price is set by supply and demand of gold in the London Bullion Market. For this article, when I mention the gold price, I refer to the spot gold price in London.
The GLD share price tracks the gold price, mainly through arbitrage. When, for example, the price of GLD trades at a premium to the gold price, an Authorised Participant (AP) can collect a profit. The AP can buy gold, deposit the gold at the Trustee, which creates shares in return for the AP, who can sell these on the stock market. This process will drive up the gold price and lower the price of GLD. APs will jump the arbitrage opportunity until the gap is closed. Naturally, the arbitrage works the other way around when GLD trades at a discount to the gold price. In this situation, APs will redeem shares at the Trustee to get gold out that they can sell in the London Bullion Market.
Below you can see a simplified graph I have made of the creation and redemption process of GLD shares.
Source: Jan Nieuwenhuijs | Voima Gold
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