Thursday, July 15, 2010

GLD revisited

… for the first time since yesterday.

I don't want to run this subject into the ground, but given the heavy seas the American economy is almost guaranteed to experience in upcoming years, the question of how (or whether) to invest in gold is important. Rightly or wrongly, many people believe that gold is the investment you can count on when the going gets rough, or that its price is headed to the moon, or both.


At the Financial Sense Web site, Erik Townsend discusses various ways to own gold, including through the GLD exchange traded fund that we beat up in the last posting. The author's bio note only describes him as "a private investor based in Hong Kong," or in other words, a bloke trying to make money in the markets. Then again, he doesn't appear to be a fund manager writing to lure clients, which is a good sign.

His article is long-winded and repetitious, but seems intelligent. I think he makes a good case for the important distinction, whose significance I hadn't fully comprehended, between owning allocated and unallocated physical gold. We won't get into that here; read his article and he'll tell you about it. Several times.


Townsend also has his say about GLD, and while he doesn't recommend using the ETF as a hedge against catastrophe, he believes it's useful as a trading vehicle. And he finds most of the fears about GLD's integrity mistaken or overblown.
In my opinion, the GLD ETF represents a far more sound investment than an unallocated bullion bank account, although neither will help you in a true crisis (where an allocated account will).

Most ETFs, including the GLD, supposedly have all the gold to back all the shares. (There are some gold ETFs that do not use physical gold backing, but these are few and small.) Critics have argued that some of the ETF custodians could be leasing out some of the gold owned by the ETF, and thus there might be multiple ownership claims on the same bullion.

There is no evidence that any of the major ETFs offered by money center financial institutions do this. The criticism is limited to speculation by others — usually people with a vested interest in discrediting the ETFs — that such shenanigans could be going on.

Another claim made by critics is that the gold in the ETF was itself actually leased from a central bank so the ETF doesn’t really have clear title to the metal. Again, there is absolutely no evidence that this in fact is the case. Frankly, I think these allegations amount to fear mongering on the part of critics who have a financial incentive to scare investors away from the ETFs in favor of other products being sold by those same critics or their associates.
He then cites a section from the Authorized Participant Agreement, which presumably sets forth the legal status of the gold in the vaults.
I am not a lawyer and I’m not qualified to give legal advice, but that language seems pretty darn clear to me. The authorized participants (who create GLD shares by depositing gold) have to deliver clear, “unencumbered” title to the gold. Could other parties also have a claim on that same gold? This language is pretty clear in saying that liens, security interests, claims, options, etc. are all prohibited. Clear, unencumbered title to the gold must be transferred to the trust when an Authorized Participant creates new GLD shares. Period.
Moreover, he says, the gold holdings are audited at least annually.
Could the auditors be fooled and miss something? Yes. That would not be unheard of. However, there are layer upon layer of safeguards to prevent this, so if an authorized participant has defrauded the ETF manager, they also have the trust’s auditors fooled.
So, who is right — GLD's detractors (including the one quoted at length yesterday) or Townsend? Don't look at me. You pays your money and you takes your choice. Or not.


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