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The intention of The Golden Chalkboard is to feature a focused selection of data or rare commentary that I think will be useful to enhance your insights into the gold market and the monetary system.

The unadvertised 'Dark Side' of Wall Street's Gold ETF investment schemes

The following dialogue was excerpted from Forum discussions
August 16th & 17th, 2006.

Noble1 (8/16/06; 15:00:15MT - usagold.com msg#: 146671)
SLV

Anyone wish to conjecture on why the silver ETF, on August 14, 2006, would have to file a notification of inability to timely file form 10-Q or 10-QSB with the SEC? I think this is their first reporting period.

Their reason stated is: "The report cannot be filed due to the temporary unavailability of the officer of the Sponsor performing, with respect to the registrant, functions similar to those of a principal executive officer."

What does that mean?

See link.

Although I have always felt that the ETFs represent the next best thing to holding physical gold and silver (especially for those unwilling or unable), they are just that, the next best thing. PG and PS in hand is and always will be the most prized form of ownership.

Noble1


TownCrier (8/16/06; 15:47:12MT - usagold.com msg#: 146673)
ETFs...
As a financial tool for those who, for reasons I'll leave unsaid, find it desirable to do the things they do, the biggest convenience the ETFs offer is the ability to conjure up a short position to feed into speculative demand with the relative safety that they don't have to face any risk of potential difficulties in making delivery of scarce metallic product because by the nature of it they are short shares, not metal.

Certain parties with vested interests in preventing a runaway precious metals market for this reason LOVE the ETF... a custom-made tool to hoodwink the unwashed masses.

Amen.

R.

Noble1 (8/16/06; 17:01:19MT - usagold.com msg#: 146676)
ETFs

C'mon Randy. Be real. Your intelligence and ability to articulate has always astounded me. I always have to read your posts ten times, just like Greenspan, to begin to interpret your meaning. That is a compliment by the way. I am no match to debate you. My guess is you are an attorney.


At least the ETFs must hold their metal (big if, if performing as designed) in allocated and audited storage. And yes, they do hold physical metal(lots of phyical). Of course, we all understand that allocated storage is not subject to physical shorting. An entity shorting an ETF is shorting shares, as you state, not the metal itself. Just as those those buying--own shares--not metal. But from what I understand, for every share (basket issued)---there must be physical backing it. Shares that are shorted do not result in the sale of physical---As opposed to redemption of shares. In the future, lets explore how this could affect the physical price discovery mechanism. Do you honestly feel that shorting ETF shares would drive the physical market? Maybe so, please explain how?

Also, wouldn't you consider it a "big convenience" for the average individual with an IRA, or a pension fund without the ability to invest in physical, to participate in the gold market via an ETF. The hundreds of tons that have been taken off the derivatives market since the introduction of the ETFs has (in my opinion) had a tremendous (favourable) impact on the price of the physical market.

Granted, self directed IRAs can be set up to invest in gold. But, you still don't get to take possession of your metal. You can't directly deposit metal that you currently own. You must rely on a custodian to hold your metal. I'll bet you can't ask for delivery of that metal. I'll bet you have to liquidate in USD. Think about the setup and maintainace fees. ETFs do have their place. Don't cook the goose that lays the golden egg.

Again, I reiterate, PG and PS represent the most desirable and ultimate form of precious metal ownership, but lets not be so intolerant to appreciate other closely allied products that may be the only alternative for some investors.

Noble1


TownCrier (8/17/06; 00:11:55MT - usagold.com msg#: 146678)
Noble1, being an engineer not prone to flights of fancy, I'm "keeping it real"
Accustomed to the typical absence, I'm usually pleased with any feedback at all, and so I'll thank you all the more for this and the additional compliment. Thank you.

Among the lot of gold advocates who do double duty as intrepid proponents of the ETF, I think that they, for the most part, have rushed in on a whim and have not critically absorbed the requisite breadth of details to fairly assess the situation in any degree approaching totality.

And who could blame them? Unless you are a person predisposed to this line of investigation and thought, it is sure to be put aside as an insufferably dry task.

While I won't pretend that this post can serve as surrogate for that intimate process, I will at the very least try to offer some key highlights to help fuel any eager adventurers along on their difficult journey.

To begin at the most natural beginning point in this abbreviated session of shared cognition, it serves us well to scrutinize that point you have made in common with many others as if it were the most glorious characteristic offered by the ETF -- namely, the notion that it possibly serves as the only avenue of "physical" gold investment available for participation by some individuals and funds.

Lord A'mighty, it's a miracle!! Thanks to the ETF, or so this line of reasoning would have us believe, a great deal of physical metal has been "taken off the market" by these otherwise palsied investors. Supposedly, this shabbiest of thinking informs us, were it not for the avenue of the ETF we are to believe that all of this pent-up investment desire for gold would just evaporate in the face of the old roadblocks (i.e., lack of ETF avenue), and apparently all of the metal not consequently so absorbed by the very presence of the ETF would alternatively flood the market and suppress the price/value due to lack of buyers.

If not fatuous in totality, it certainly is in large part.

Or, to see this same thing from the reverse angle, consider the goldless investor who finds himself newly with a desire for diversification into gold. If the avenue of the ETF allows him to divert a fraction of his pension funds into the ETF shares, there is indeed a great likelihood that he will then consider that itch suffiently scratched. That is, he will consider that he has now all the gold he needs, the matter closed, and he will not pursue the idea of gold ownership any further -- not to a more tangible conclusion following a committed pursuit of personal gold ownership of coins and bullion.

There is no telling if -- nor does it really matter(!) -- if the shares of the ETF he has naively purchased were among "original" shares created upon the transfer of actual gold into the Trust's allocated account, or if the shares are among the less viscerally satisfying -- that is, those that have been artificially, yet effectively, created above and beyond the gold-backed shares via the stock market brokers' traditional borrowing and shorting facilities.

If a reader doesn't understand that very fine point of share expansion, I'm afraid that they have much homework to do. However, the important thing to grasp is that shares above and beyond the naively anticipated "gold-backing" can be brought into existance to appease gold appetites, thus helping to ensure that it does not pursue metal any further through traditional physical avenues.

In other words, the ETF, through original shares and borrowed/short shares, can help bullion bankers expand a given supply of physical gold into a means to provide the very real (yet deceptive) appearance/effect of fulfilling (falsely) the desires of more investors than would otherwise be the case.

To my mind, on the basis of mere morality and beyond, it would be better to strip away this charade completely, even if it means that it undoes the ETFs primary benefit thus causing some unspecified body of investors to be inconvenienced to seek recourse to the more traditional gold investment avenues to attain their desired level of diversification.

it seems to me that consequently, barring the ETF, the gold it presently holds in trust would become well spoken for -- perhaps several times over.

Speaking of which, it would serve our purpose well to briefly speak on the disposition of this gold in the first place. Ill-informed ETF proponents like to claim that the ETF managers must acquire ever more gold as people buy ETF shares. Not so. Once a supply of original shares has been created (in conjunction with metal allocation), it is simply these shares that trade back and forth, further supplemented, as I stated earlier, by quantities borrowed short.

New "full-bodied" shares with "gold backing" are created only at the pleasure of the Authorized Participants -- that being the bullion banks who retain the unique authority to create or redeem shares with gold deposits or withdrawals from the Trust's allocated account. And on this very fine point a person must strive against the impossibly difficult task of understanding that the quantity of metal so entrusted (for share creation) need not itself present a squeeze upon the open metal market in the course of its commitment. Why? Because this metal may already reside in the Authorized Participant's possesion, or it may be gently borrowed from unallocated accounts from a peer, or a combination of both, and more.

How long does it take, with fancy paper maneuvers, for a bullion bank to whether a speculative storm? I should venture the seasoned guess that a vested interest (such as a bullion bank) has more staying power than the ill-informed and ill-equiped masses who simply pursue the shifting scents of potential monetary gain with a sense of greed and attention that is no more focused than a puppy amongst a flock of butterflies and scattered candies.

And on that note of easily-distracted investor psyche, this seems like the perfect opportunity to spare myself some typing for a change and introduce you to some comments own near and dear Mike Kosares recently offered in an e-mail discussion on this very topic. As I have another look for a suitable excerpt from among his comments, I see this one bloc where he actally provides a tidy recapitulation of some of what I've tried to say above, and then gets on to the point at hand regarding the effective bullying of those humble masses of potential gold investors:

MK writes,
"ETF's may have had a postitve impact on the gold price in that a whole new market has opened up for the physical metal -- a market that might have otherwise gone untapped -- but this fact is a separate consideration from the shorting aspect. In fact the ability to short might nullify the physical offtake. On top of that those wondering about the effect of ETFs on the overall market shouldn't turn a blind eye to the volatility fund traders (the prinicple and intended market for ETFs) bring to the market. That volatility is already manifest in the market and could become a greater influence as volume increases. Let's not forget that in many instances the typical fund trader is in the precious metals market for short-term cash profit, not long-term asset preservation like the average upper-middle- and middle- class investor."

Noble1, you also got into the tangent of IRAs, and for the most part your suppositions on gold deposit and withdrawal from a trust company's fiduciary account are terribly erroneous. This post has become overly long and I'll leave elucidation on that score to another day, but in the meanwhile you would strike nearer the truth of the matter to take the opposite of what you said in your second-to-last paragraph, and would be better served hearing what George Cooper, not I, could testify on that particular matter.

Best regards,
Randy

Noble1 (8/17/06; 07:24:05MT - usagold.com msg#: 146690)
ETF Short Shares msg#: 146678

Randy's quote:

"There is no telling if -- nor does it really matter(!) -- if the shares of the ETF he has naively purchased were among "original" shares created upon the transfer of actual gold into the Trust's allocated account, or if the shares are among the less viscerally satisfying -- that is, those that have been artificially, yet effectively, created above and beyond the gold-backed shares via the stock market brokers' traditional borrowing and shorting facilities."

Thank you. Light bulb goes on in my head.

Noble1

Editor Note: Never one to be left too far behind, the Wall Street Journal, almost exactly 6 months to the date after the conversation above took place, has finally offered some some of its own beneficial insight on this same topic to would-be participants, users and abusers of the realm of ETF shares. The article, as brought forward by GATA's secretary, Chris Powell, has been provided below. A subsequent article by DowJones has also been provided as of May 14, 2007. The world is appallingly slow to wake up to that which we've been cautioning against since the very beginning. Chris Powell (2/19/07; 18:11:54MT - usagold.com msg#: 152350) Invest with Barclays and watch it sell you short Barclays Puts ETF Portfolios To Good Use Securities Lending Helps Juice Returns, Revenue; Potential for Conflicts By Tom Lauricella The Wall Street Journal Friday, February 16, 2007 Barclays Global Investors has become a dominant force in the business of running exchange-traded funds, partly on the appeal of the low fees it charges investors on these mutual-fund-like products. Another aspect of its business that is less well-known to ETF investors: Barclays actively engages in securities lending -- loaning out the stocks and bonds in its iShares ETF portfolios. The loans are highly lucrative, bringing in millions of dollars a year for Barclays in addition to the fees it gets for managing the funds. Securities lending isn't new, but it is growing increasingly common in the fund industry. Such lending has particular appeal for ETF providers. The profits can boost an ETF's returns -- and in the world of index funds such as these, a small amount of additional income can make performance appear significantly better. Demand for borrowed securities has skyrocketed thanks to the growth of hedge funds employing a "short-selling" strategy. In this strategy, investors bet that prices will fall by selling borrowed shares in hopes of replacing them with cheaper ones bought later, and pocketing the difference. The Securities and Exchange Commission has ramped up its scrutiny of securities lending in general but especially in cases where an arm of the fund-management company also gets paid for helping broker the lending arrangements. There is potential for conflicts arising from the fact that the interests of the fund-management company arm don't always align with the interests of investors. It is in the fund company's interest to take as big a cut as possible from the lending profits, while it is in the interest of shareholders for the opposite to happen. At Barclays, a unit of British bank Barclays PLC, the loans boost its profit from some of the index-tracking funds by double-digit percentages, typically 10% or so. But in a few cases, the gains are significantly higher -- at its Russell 2000 fund, for instance, securities lending effectively boosted Barclays' revenues from the fund by 50%. Meanwhile, for ETF investors, the income that iShares funds receive from lending generally increases returns by 0.01% to 0.15%, according to Barclays. Barclays says it runs its program in the interest of fund shareholders and complied fully with SEC rules when setting up its securities-lending process. It splits proceeds 50-50 between the fund-management company and its iShares ETFs. The fees Barclays receives "are fair and reasonable," and the agreement benefits shareholders by providing additional income, says James Parsons, a managing director at Barclays. Barclays isn't the only firm that gets paid for helping its own funds lend out securities: Goldman Sachs Group Inc. and J.P. Morgan Chase & Co. are two other examples. But in relative terms, Barclays gets a bigger boost in revenue from lending than managers of actively managed funds (as opposed to index-tracking funds like ETFs) given that actively managed funds charge higher advisory fees. Here's how securities lending works: A fund loans out some of the stocks or bonds it holds in exchange for collateral, usually cash. That money is reinvested into a low-risk investment to provide additional returns for the fund. The lending is typically done through an agent whose job is to find customers needing to borrow. The agent takes a cut of the money earned from the loan. The share kept by agents varies, ranging from 10% to 50%. Many funds use an outside company as an agent rather than an affiliate of the management company. Among major ETF providers, State Street Global Advisers, like Barclays, is a big player in both the ETF and securities-lending businesses. State Street currently contracts with an outside agent and doesn't get paid to help its funds with securities lending. Mutual-fund giant Vanguard Group also lends securities, using an in-house broker, but says that all the income goes directly back to the funds. Such arrangements with in-house lending agents have drawn the scrutiny of the SEC. An examination of mutual-fund practices found instances where fund companies may have improperly tilted the bidding process toward in-house lending agents when fund boards were looking to contract out the business. ETFs have attributes that make them particularly attractive for securities lending. Based on indexes, they hold a wide range of stocks, and the portfolio composition is fairly predictable. And as ETFs have become more narrowly focused -- some newer ones target tiny corners of the market, such as biotech stocks -- there's a chance that an ETF company will hold stocks sought by borrowers. Typically, international and smaller-company stocks are the hardest to borrow, and thus the most valuable for a lending agreement. Barclays, which is among the biggest players in securities lending, has been the lending agent for iShares funds since 2003. The staff of the SEC requires that when a fund board considers an affiliate of the management company as an agent, it must comply with several specific requirements, including that fees charged are "fair and reasonable" when compared with outside vendors. Barclays says that its funds followed that process required by the SEC. In its role as lending agent, Barclays collected $1.5 million in fees on the iShares Nasdaq Biotechnology fund for the year ending March 2006, amounting to an additional 19% above its basic fee for managing the fund (which totals 0.5% of assets). It is a similar story for its Standard & Poor's SmallCap 600 fund, where $1.6 million in lending fees added up to an additional 20% above the management fee. Barclays also profits off of securities lending on its bond funds. For its five funds based on indexes from Lehman Brothers Holdings Inc., Barclays received $4.4 million in lending fees, equaling a 23% boost above the $18.9 million in advisory fees it earned. For shareholders, the magnitude of the income boost is much smaller. In the Russell 2000 fund, the bump up in income for 2006 amounted 0.083%, Barclays says. However, the firm says that additional yield should be compared with the earnings that other fund companies generate for their portfolios through securities lending. In 2005, Barclays says, its securities lending program helped the company's ETFs exceed yields on comparable funds by 16% to 357%. For example, Barclays says that on Russell 2000 index funds offered by other companies, the nearest competitor only earned half as much on securities lending as the iShares fund. Chris Powell (usagold.com 17May2007; 13:01) Exchange-traded funds are great tools for short-sellers ETFs Offer Advantage for Short Positions; Uptick Rule Not Applied By Ian Salisbury Dow Jones Newswires via National Post (Financial Post), Toronto Monday, May 14, 2007 NEW YORK -- Exchange-traded funds are known for their ability to accommodate short sellers -- but with some ETFs short selling may be the chief reason for investors interest. Stocks often post "short interest," the percentage of shares sold short, of 5 percent or less. Short interest of more than 10 percent is considered high. Short interest in ETFs can be much higher: A recent report by Morgan Stanley, found that, as of March 31, there were eight ETFs with short interest of more than 100 percent. The high short interest is due in part to the unusual structure of ETFs, which allows new shares to be created expressly for the purpose of shorting, and in part to their usefulness as baskets of stocks for institutional investors to hedge their market bets. ETFs resemble index-oriented mutual funds, but trade on an exchange like a stock. As with stocks, investors can "short" ETFs, a technique allowing them to bet against a particular sector of the economy or to hedge other investments by canceling out bullish bets in another part of their portfolios. Shares are shorted by borrowing them from a brokerage firm and selling them on the open market. The investor hopes to reap a profit if the shares fall in value, when they can be bought back at a lower price. In some ways, ETFs are even easier to short than stocks. Investors can short stocks only on an "uptick," when the price has recently risen. The regulation prevents bearish investors from piling on when a stock is falling. Most ETFs are exempt from the "uptick" rule. As baskets of securities, ETFs can be more useful than individual stocks for institutional traders as hedging tools, so interest isn t limited to bearish investors. Also, while the number of stocks of an individual company that are available to trade is relatively fixed, the number of shares of an ETF fluctuates with investor demand. If a brokerage firm that deals in ETFs sees sudden market demand from short sellers, it can create new ETF share just for that reason. In the Morgan Stanley study, one fund, KBW Regional Banking EFT, had short interest of a whopping 3,676 percent on March 31. That number implies that shares of the tiny fund -- it had US$9 million in assets at the time of the study -- had been lent and re-lent more than 30 times. Morgan Stanley reported the short interest on April 24 at lower, but still vertiginous, 1,838 percent. The bearish interest in the regional banking ETF may be from investors who hoped to capitalize on problems in the U.S. subprime mortgage industry. It could also reflect investors moving short bets from a larger regional bank ETF into the small KBW Regional Banking ETF.

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