Tuesday, January 10, 2006

Gold ETF

What is a gold exchange traded fund (Gold ETF)?

A Gold EFT is an exchange traded fund with gold being the principle and only commodity being traded. When you "buy gold" via a GOLD ETF it is very different to the general practice to buy and sell gold which most people are familiar with. To understand what gold ETFs are we need first to have some idea of what an exchange traded fund (ETF) is.

Exchange Traded Funds
Exchange traded funds (ETFs)were first introduced on the Toronto, Canada, Stock Exchange around the early '90s. They were then introduced in to the US and other markets during the 90s.

A simplified definition would be: An exchange traded fund has funds and stocks in one product and trade is made on the particular fund. Prior to ETFs, stocks and funds, were traditionally kept separate to reflect liquidity issues.

The purpose of an ETF is to be able to invest in the growth of an industry or even commodity that was not easily available to the market prior to ETFs.

Some benefits of an EFT include:
No stamp duty to pay (duty already paid on the underlying investments)
Flexibility in the timing of purchases and sales
Availability online.
Some disadvantages include:
No control over the activities or the content of the ETF.
Different costs associated with trading ETFs as distinct to ordinary shares
Tax implications
Hidden annual management costs ( the costs are built into the fund pricing)
No guarantee that you actually own gold.
The investor cannot redeem the gold or take delivery of the gold, only cash.
Gold Exchange Traded Funds
Gold ETF or gold exchange traded funds, are similar to trades, then, of other commodities and resources except that the shares "reflect" the price of gold, usually gold is stored by the Gold ETF in the form of ‘400 oz’ London Good Delivery bars.

The institutions administering the fund, such as StreetTracks for example, the biggest gold EFT in the USA, hold gold bars in bank vaults "backing" the holdings of their clients. This is taken to mean that, instead of having to own and cart around gold bars to buy and sell, the EFT fund holds gold bars in trust and you buy a proportion of that gold holding when you open an account with the custodian which is reflected in your account statement.

A closer look, however, shows some disparities in this as discovered by James Turk, the editor of Freemarket Gold & Money Report and the founder of GoldMoney.com

StreetTracks, the Biggest of the Lot
On the gold ETF fund (GLD)website of StreetTracks it states, " The objective of the Trust is for the Shares to reflect the performance of the price of gold bullion, less the Trust's expenses." This is quite different to stating that, "We act as a custodian and hold gold for our clients ." Their statement does not indicate one is trading in actual gold but that when you buy into a StreetTrack Gold EFT you are buying into a trust that is designed to "reflect" the share price of gold. And although one has 'shares' these shares do not come under the normal safeguards provided to shareholders of ordinary companies as is stated in their prospectus.

James Turk, in an article about StreetTrack, points out, "Its objective is not to provide investors with the opportunity to own gold bullion by investing in the shares of an Gold ETF. Rather, GLD is designed to track the price of gold. That objective is no different than what is accomplished by a gold futures contract or any of the dozens of numerous gold derivatives available these days. More to the point, futures and derivatives are sold even if the seller does not own the underlying gold bullion needed to deliver on its obligation. They are in practice fractional reserve systems, which allow liabilities for gold to far exceed the quantity of gold owned by the seller of that liability."

He also added, "Without strict controls over the assets of the fund, almost anything is possible. What if, for example, GLD were double-counting the same bar of gold? Impossible, you say, but James Turk goes on to say…

"Well, the GATA army has done it again, and thanks go to Stephen Marney. He analyzed the gold bar list reported to investors that shows the gold supposedly owned by GLD.

Last week Stephen brought to my attention that of the 6,981 gold bars reported on the list, there are 78 duplicate bar numbers. This result is staggering. It means that the genuineness of 156 bars, or 2.2% of the total assets of GLD, is called into question."

So questions investors should be asking themselves before they commit their fund is, does this mean that StreetTrack does not actually have as much gold as was first thought? In addition, it states quite clearly on the web site that a member of the public cannot actually take possession of the gold, 'they own'. Does this mean that there are some situations where an investor could potentially lose their funds?

What does all this mean? Well basically it means that an investor has to do some due diligence and really understand what a Gold ETF really is and what it isn't. Clearly an investor is not buying actual physical gold and they would be if they buy gold coins or bars from a gold dealer.

An investor has to ask themselves the question, then, "Do I want to actually own gold, or simply shares in it?

When you own actual physical gold, either in your hand or in a bank vault, properly audited and your account shows ownership of actual physical gold, there is no disputing the fact.

So, despite the hype and push to sell the Gold ETF by excited brokers, I will still be keeping my value in real gold coins and bars that you can hold in your hand!


Anonymous said...

This was posted at lemetropolecafe.com:

I was told by a friend that he felt much better owning GLD than physical gold because there were no storage fees, it was more liquid than physical gold in his possession and he did not want it to be stolen. I then asked him WHY he held any gold at all and his answer was "I keep 5% in gold in case of catastrophic problems with the monetary system."

After I finished laughing I pointed out the following risks associated with investment in GLD and not physical Gold:

- GLD is held and controlled by banking institutions that will likely be insolvent in the event of a monetary system failure....RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Sponsor (World Gold Trust Services) resigns or is unable to perform its duties or becomes bankrupt or insolvent....RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Trustee (Bank of New York) resigns or is removed ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if DTC, the securities depository for the Shares, is unwilling or unable to perform its functions...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Shares are de-listed from the NYSE ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the NAV of the Trust remains less than $50 million for a period of 50 consecutive business days ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Custodian (HSBC) resigns ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the authorized Participants (JPM, Goldman Sachs, Etc.) redeem the trusts assets ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the Trust fails to qualify for treatment, or ceases to be treated, for US federal income tax purposes, as a grantor trust ...RESULT: NO GOLD

- GLD can be liquidated (available cash only) if the maximum period for which the Trust is allowed to exist under New York law ends ...RESULT: NO GOLD

- GLD shares are "supposedly" held by your broker so you take the brokers default credit risk....RESULT: NO GOLD

Add them all up and I'd say GLD is a VERY risky asset to own in the case of a monetary crisis.

He should just buy physical and hide it in a better place!

All the best.
PS - For SLV you can pile on about 10 more risk factors!

b4freedom said...

ETF’s like GLD are good for short term speculation. And that’s about it. For example, Monday I purchased $10,000 of GLD. My broker told me I was an idiot and that “There is lots of gold and that it’s overrated.” Today I’m VERY happy; I wanted to call him all day and tell him what a loser he is…

But GLD isn’t good for the long term. For that, just get the real thing.

Anonymous said...

In this economic climate I think buying gold, whether bars or coins is safer rather than GLD. Have something in your hand the stuff that when you drop it on your toes it hurts!!!!! Be in control of your assets at this present time, until things settle down.