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TheStreet Open House

The Road to Bullion Default: Part II

Stocks in this article: GLD SLV AIG HBC JPM

This may not seem like an especially dire event, especially if the funds involved were smaller, and thus had a lower profile than some of the mega-bullion funds in the marketplace. However, consider the inevitable human reaction whenever something bad happens to an investment very similar to one of our own.

All holders of bullion funds (and bullion ETFs) would immediately take a much harder look at their own holdings, to see if their own investments faced similar (or different) vulnerabilities. Here is where some seemingly insignificant collapse of a minor bullion fund/ETF could quickly mushroom into a market-ending event.

Regular readers are familiar with my frequent criticisms of the two largest bullion funds in the world: the bullion ETFs known (by their U.S. trading symbols) as SPDR Gold ETF (GLD) and iShares Silver Trust (SLV). My suspicions here are obvious: Any close scrutiny of either of these two funds reveals a totally preposterous business model -- fraught with massive counterparty risk for anyone foolish enough to hold units in either fund.

While readers looking for a more detailed critique can refer to previous commentaries (such as The Seven Sins of GLD , for the sake of brevity I will focus on just one glaring anomaly: the blatant, gigantic conflict of interest involving the custodian of each of these funds.

In the case of GLD, the custodian for virtually all its gold is banking behemoth HSBC (HBC), the largest gold-short in the history of the world. As already noted, it's nothing short of preposterous that the world's largest gold-short is also the legal custodian for the world's largest long bullion fund. It is the epitome of the cliche "the fox guarding the henhouse."

More than that, it's a patently obvious conflict of interest. GLD markets itself to unit-holders as "the cheapest way" for investors to (supposedly) "hold bullion." Unit-holders buy more or less at the spot price, and (as custodian) HSBC subsidizes these unit-holders by absorbing most of the costs of storage.

Obviously, subsidizing the entry of small, long investors into the gold market directly undermines HSBC's multi-billion dollar short position. We are left with only two possible conclusions. Either HSBC is engaged in one endless act of gross negligence through undermining its own short position by subsidizing these long investors; or, the true nature of the fund is not as it is portrayed to the investing public.

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