by James Turk
The exchange-traded fund for gold (NYSE:GLD) has been described as a convenient way to buy and sell gold bullion. Consequently, GLD has been heralded as a major breakthrough for gold buyers, but is it?
I have been and remain critical of GLD, and have written several reports since its launch five years ago. I consider GLD to be risky because its prospectus says that gold reportedly owned by the fund but stored in subcustodians and sub-subcustodians is not audited and cannot even be inspected to ensure that it really exists. Nor is it insured. Further, the prospectus allows for the possibility that all of the gold supposedly owned by GLD is subject to the considerable numerous risks spelled out on pages 6 through 13 of GLD’s prospectus, including the significant risk that “Shareholders do not have the regulatory protections provided to investors in investment companies.”
GLD presents its financial statement in 10-K reports filed with the Securities & Exchange Commission, and these are revealing. GLD's balance sheet states its major asset to be: “Investment in Gold”. It does not say just: “Gold”. This classification declaring GLD's asset to be an investment in gold rather than gold itself provides an easy hurdle to meet for auditing purposes.
Investments in gold can be nearly anything gold related, and for example, include gold certificates and other promises to pay gold. GLD does not have to prove to its auditor that each share in issue is backed by gold in the vault. Rather, all GLD has to do to satisfy its auditor is to simply show them an account statement (i.e., a piece of paper) from any subcustodian or sub-subcustodian that says gold is owed by them to GLD.
If GLD declared its asset to be “Gold”, it would have to substantiate to its auditor that the gold really exists. The auditor would need to visit each and every vault where gold is stored, which neither the management of GLD nor an auditor can do because of the inability stated in the prospectus to audit or even inspect gold stored in subcustodians and sub-subcustodians.
Thus, the 10-K clearly re-confirms what others and I have concluded all along – that GLD is just another paper scheme. It should not be considered as an alternative to physical gold ownership because it is not. But we only need logic, and not the 10-K, to tell us that.
Since launching in November 2004, GLD has reportedly gathered over 1084.3 tonnes of gold ($34 billion at current market value). Of this amount, 420.5 tonnes – which is 17% of all the gold mined last year – were added in the past twelve months, a 63% increase in just one year. But what has happened to the gold price during this period?
Gold has fallen from its $1,003 record high one year ago by as much as $298 (a 30% decline) to $705 on November 13, 2008, and even now as I write one year later on March 18th, gold remains $114 below last year’s high price. How is it possible that GLD increases the demand for gold by 63% and absorbs the equivalent of 17% of all the gold mined last year yet the price of gold still declines?
Its sponsors would have us believe that these 1084.3 tonnes are newly created gold demand, but this proposition is self-evidently outlandish.
So instead of creating new demand, one should be asking, what would be the impact on the gold price if the $34 billion GLD manages would have been used to purchase physical metal if GLD hadn't existed? How much higher would the gold price be today if GLD wasn't launched?
My point is that without any third-party verification that all of the gold owned by GLD really does exist, GLD is just another paper product offering exposure to the gold price. The prospectus clearly states: “The investment objective of the Trust is for the Shares to reflect the performance of the price of gold bullion, less the Trust’s expenses.” The objective is not to provide individuals an alternative way of owning physical metal.
So do not view GLD as an alternative to physical gold, because it's not. GLD should be compared to a gold futures contract, not to physical metal.
1) A futures contract tracks the future price of gold in the form of a tradeable contract. In a similar vein, GLD tracks the spot price of gold in the form of a tradeable security.
2) There is no gold backing any individual futures contract outstanding, and there is no audited proof that there is physical gold backing every GLD share in issue. What’s more, to the extent that GLD is sold short, even if the gold in GLD backed every share in issue, the gold equal to the amount sold short would be owned by two shareholders – the original buyer and the buyer who purchased the shares sold short.
However, there are differences of course between a futures contract and GLD. One can convert their futures contract into gold by taking delivery. An individual GLD shareholder cannot do that. Only a so-called ‘authorized participant’, which are the big bullion banks, can. So in my view this limitation makes GLD less useful to individuals than a futures contract.
I favor the concept of a gold exchange-traded fund. However, physical metal is one thing, and the paper representation of metal like GLD is something entirely different. Importantly, it is physical gold itself – and not just the promise to pay metal – that is the bedrock asset of one's portfolio.
Consequently, use GLD as you would a futures contract – as a trading tool. It is not an alternative to owning physical metal.
Copyright © 2009 by James Turk. All rights reserved.
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