commodity ETFs: what effect do they have on the market?

[grapejelly]

There has been a small scale mania for turning commodities into stocks via ETFs.

I think there may be problems with the commodity ETFs and that they may blow up. They may function to hinder the free markets, who knows...something about them is not right.

But I'd like your opinion.

The problems may lie in treating commodities as if they were paper.

The ETFs require agents to purchase additional commodities, say gold, when people buy more shares into existence, or to sell gold when people sell shares.

In a market that melts up parabolically, the shares will be bid up, say, by US$100 in a session, and yet the GLD trust may not be able to buy that gold.

This is a flaw...but it lies in the future. With a normal market it's not a problem.

Also, in a meltdown, the ETF is dumping vast amounts of commodity (say gold) onto the physical market. What effect does this have on the market for physical?

I intuit that there is a big problem with these ETFs but I would like to know what you think.

[WDCRob]

Re: commodity ETFs: what effect do they have on the market?

Probably a naive question, but when does the ETF have to buy or sell the underlying commodity to maintain the net paper position? i.e. what's the lag?

[jk]

Re: commodity ETFs: what effect do they have on the market?

try, for starters

http://www.zealllc.com/2006/gldetf.htm

[Spartacus]

Re: commodity ETFs: what effect do they have on the market?

For most commodities the effects should be nil - so much copper is mined and used, for example, that huge, HUGE amounts would need to be stockpiled to make a dent on supply-demand issues.

For Gold, Silver, Platinum, Rhodium, Palladium, and the rare earths the situation's different - so little is mined (and sometimes so little has ever been found), that locking up a billion dollars worth takes a big bite out of world supply-demand curves.

The Platinum ETF was declined because of supply issues, wasn't it?

It also creates an interesting situation for the conspiracy buffs, though, to have huge stockpiles sitting there under the control of the likes of JPM (for the Silver and one of the Gold ETFs) or other such entities, and audited by other large entities - the senior staff or the auditors and the audit-ees change places with senior staff of Government Regulatory bodies and senior Central Bank personnel on a regular basis (can you say "Goldman, Rubin, Paulson and GATA"? I knew you could.)

[Spartacus]

Re: commodity ETFs: what effect do they have on the market?

>> The ETFs require agents to purchase additional commodities,
>> say gold, when people buy more shares into existence, or to sell
>> gold when people sell shares.

The sequence of events is the reverse of this in Silver, the one case I've explored in depth - the Silver must be in place before the shares are issued.

The way the Silver ETF works is, a "registered participant" (mostly large stockbrokers, from what I gather - 11 were approved at the ETF's launch, more may have been added since) asks the JPMorgan facility in London to sequester X ounces of Silver, in 500,000[1] ounce blocks.

The JPM London vault is part of LBMA, and apparently takes Silver out of LBMA pooled accounts[2] in order to service the ETF's needs (pooled Silver may not be used for the ETF - the JPM vault is allowed to allocate at most 100,000 ounces of Silver to the ETF from a pooled account, and that on a very temporary basis).

JPM tells the RP the Silver's been sequestered, and at that point the RP then may issue additional shares of the ETF based on the newly-sequestered Silver.

Redemption works in reverse.

Probably a naive question, but when does the ETF have to buy or sell the underlying commodity to maintain the net paper position? i.e. what's the lag?

The Silver one that I detail was based mostly on one of the existing Gold ETFs. The major detail I was looking for when I researched was whether the physical metal was completely dedicated, or whether it could be pooled or sold short.

You need to read the prospectus of each one - There's a specific section of the securities law that most of the commodity ETFs have been operating under, and I do not know if that law demands the ETF must have sole ownership of the underlying commodity. That question is up in the air for me, until I get some time to research it.

So the next ETF might theoretically allow the use of pooled Gold/Silver/Platinum or whatever - meaning that others might have first dibs on the metal you "think" your ETF owns. Again, read the prospectus.


[1] I'm probably wrong on this - it may be 50,000.
[2] This is just a description of what JPM has apparently been doing, its current practice - it's not a requirement in the prospectus that JPM get the Silver from LBMA pooled accounts - theoretically, JPM could get some Silver from COMEX[3] the prospectus just demands that the ETF's Slver may not have any other claims on it (IOW, it may not be pooled).
[3] yes, I am joking - although I wish it would happen[4]
[4] although of course the theory currently holding sway is that the Silver ETF's first 130 million ounces was all of Buffett's Silver, most of which apparently did come off COMEX.