Gold & ETFs

The Financial Times – Good as GLD :

While it has now become possible to buy and sell gold with a few mouse clicks through funds like the $51bn SPDRS Gold Trust (GLD), now the world’s second-largest exchange-traded fund and sixth-largest owner of gold worldwide, old-fashioned ownership of bars, coins or stakes in mines has surged too. But, unlike shakier exchange traded notes, gold ETFs are backed by physical assets rather than pieces of paper.

It is debatable whether profligate governments and easy money justify gold as a financial investment, but the notion that one can only trust tangible gold is more than a bit ridiculous. So is the notion of a gold shortage. More than any other commodity, the amount of gold above ground far exceeds actual consumption. History has shown that, even during war, hyperinflation or famine, someone will always sell or barter their gold. And suggestions that governments, whose currencies are no longer backed by precious metals, would confiscate gold as the US did in the 1930s or that they are engaged in a conspiracy to distort gold reserves, are outright paranoid. Part of gold’s historical appeal was its portability and immutability. But insisting on direct ownership only makes investing in it unnecessarily cumbersome and expensive. The only people who profit are miners, promoters and vault manufacturers, not the fearful goldbugs themselves.

As we posted on May 13, gold hit record highs in many major currencies as fears about the financial system’s stability continued to rise. Over the past year gold’s popularity has made the GLD fund the second-largest ETF with just under $50 billion in assets, trailing only State Street’s SPY fund in terms of total assets. The next largest gold fund in terms of assets, COMEX Gold Trust’s IAU, has roughly $3 billion in assets (not pictured).

With this increase in popularity comes much increased scrutiny about the fund, although a quick glance over the prospectus and quarterly statements prove many of the concerns raised by investors to be overblown.

One criticism often raised about the GLD fund is its lack of transparency regarding its holdings of physical gold. Does the fund use derivatives and own “paper gold” or does it own enough bullion to support redemptions by all its shareholders? This concern can be quickly put to rest after reading a couple points in GLD’s prospectus. First, on page 14 of the GLD prospectus (page 16 of PDF) the amount of physical gold held in its vaults is stated:

As at March 31, 2010, the amount of gold owned by the Trust was 36,324,952 ounces with a market value of $40,520,483,790 (cost – $30,289,189,919), including gold receivable of 166,431 ounces with a market value of $185,653,480 based on the London PM Fix on March 31, 2010. As at March 31, 2010, the Custodian held 36,158,521 ounces in its vault (36,158,483 ounces of allocated gold in the form of London Good Delivery gold bars and 38 ounces of unallocated gold), excluding gold receivables, with a market value of $40,334,830,509 (cost – $30,103,536,538).

Still, some are concerned that GLD may actually only own gold in paper (derivative) form rather than physical bullion. Page 16 of the GLD prospectus (page 18 of PDF) comments on the use of derivatives:

The Trust does not invest in any derivative financial instruments or long-term debt instruments.

While these concerns are definitely understandable in a time when derivatives are considered toxic in every form, the GLD fund makes every effort to calm investors fears in this respect.

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