Wednesday, April 14, 2010

Gold ETFs, the real McCoy or just paper in the wind?

Probably the biggest gold exchange traded fund is SPDR Gold Fund (GLD).
"ETF investors piled into shares of SPDR Gold Shares(GLD) to the tune of $828 million in March as currency concerns kept the metal attractive. A rise in the price of the metal helped push net assets under management up more than $1 billion, to a new high of $40.5 billion." The Street, April 2010.

The SPDR Gold Traded Exchange Fund was started just seven months after Rothschild exited the gold market in 2004.
"LONDON, April 14, 2004 (Reuters) - NM Rothschild & Sons Ltd., the London-based unit of investment bank Rothschild [ROT.UL], will withdraw from trading commodities, including gold, in London as it reviews its operations, it said on Wednesday."

Why would one of the most active traders in gold suddenly decide to withdraw from the gold market one wonders. Coincidence or not, a study of the prospectus for GLD shows some alarming statements.

In the GLD prospectus on page 11 it states:
"Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss. Neither the Trustee nor the Custodian independently confirms the fineness of the gold bars allocated to the Trust in connection with the creation of a Basket. The gold bars allocated to the Trust by the Custodian may be different from the reported fineness or weight required by the LBMA’s standards for gold bars delivered in settlement of a gold trade, or the London Good Delivery Standards, the standards required by the Trust. If the Trustee nevertheless issues a Basket against such gold, and if the Custodian fails to satisfy its obligation to credit the Trust the amount of any deficiency, the Trust may suffer a loss."

This means in effect that gold bars held in trust are not guaranteed to actually BE genuine gold bars but could easily be something else instead. Later down the page it states.

"Because neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians who may temporarily hold the Trust's gold bars until transported to the Custodian's London vault, failure by the subcustodians to exercise due care in the safekeeping of the Trust's gold bars could result in a loss to the Trust."

So no responsibility is taken for the gold bars held by LBMA Banks on behalf of the trust. In view of the latest exposure of some LBMA gold bars actually being counterfeit and really just tungsten bars coated in gold this could be of some concern to large holders of GLD certificates.

Detecting a high-quality fake tungsten gold bar is not easy. The only way to do so is to drill a hole through the bar and see what comes out. A genuine gold bar and a bar filled with tungsten is going to weigh virtually the same since tungsten weighs within a fraction the same as a gold. The density is very similar also so those two principle methods of checking gold bars are practically useless. To properly test a gold bar would likely require significant and material alterations to the bar being tested and this would negatively affect the marketability even when its hallmark veracity is vindicated.

During a recent Commodity Future Trading Commission hearing in Washington DC, Jeffry Christian of the CPM Group, testified that the LBMA Banks actually have about a hundred times more gold deposits that actual gold bullion. This means that gold is now being treated by the LBMA banks as a fractional deposit.

Alarm bells ring when you consider that most of the gold held 'in trust' by the Gold EFT, GLD is held in LBMA Banks. So of the lesser amount of gold held against the actual deposits, how much of that is not really gold at all?

If and when the proverbial hits the fan it might be better to have removed any gold deposits while they still have some value.

Investing in solid gold, rather than paper gold is probably a wiser move when more people realize there is likely much less gold available than was previously thought and the price of gold consequently shoots up through the ceiling as a result.

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