Eric Sprott: Investment Perspective (June 2013)

Redemptions in the GLD are, oddly enough, Bullish for Gold

by Eric Sprott and Etienne Bordeleau, Sprott Asset Management
Recent outflows from physical gold exchange traded products (we use the SPDR Gold Shares, GLD) have been interpreted by the financial press as a sign of weakness in the demand for gold as an investment vehicle.¹

However, a closer look at the evidence suggests otherwise: the largest outflows in the history of the GLD (see Figure 1) started well before the large drop in the price of gold we observed on April 15th, 2013 (-9%, which represents a 1 in 11 years event)². In fact, the net redemption of shares of GLD started as early as the second week of January 2013 (on a 3-month cumulative rolling basis). In this note, we will explore the theory that it was the shortage of physical gold and the ensuing arbitrage opportunity that drove market participants to redeem shares of GLD.

So why are the bullion banks³ that act as Authorized Participants for GLD, a group that includes JP Morgan and HSBC and others (who by-the-way were mostly bearish on gold leading to the April Crash), redeeming so many shares of GLD?

One explanation could be that they are trying to match supply and demand so that the net asset value (NAV) of the ETF is in line with its price. Historically, we have observed that large movements in and out of the GLD are associated with large discounts/premiums to NAV (Figure 2). This is due to the constant creation/redemption of the shares to minimize the discrepancies between the ETF share price and the NAV. However, the recent wave of redemptions has occurred even while the premium to NAV has been very stable, hovering around 0% for most of the year.

FIGURE 1: FLOWS IN THE GLD (TONNES) – 3 MONTH ROLLING BASIS

Source: SPDRgoldshares.com and Sprott Calculations.
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