Beware Gold ETF’s

There is a time to trust the system and a time to protect you and your family’s future.  This isn’t a ‘big brother is coming to get you’ statement but merely one of practical reality.  Exchange Traded Fund (ETF) ownership of gold sees a potentially costly combination of trust in the system and laziness.

Forbes last week ran an article titled ´GLD vs. Physical Gold: Which Is The Better Investment Now?’.  Their conclusion was clear… physical gold.  We wrote about some of the pitfalls of owning gold through ETF’s back in June last year and you should read it here if you have forgotten or missed it.

But Forbes raise some other details that we will summarise below.  They use SPDR Gold Trust (GLD) as the example given it is by far the biggest and most popular ETF for gold.

  • You cannot request physical delivery unless you own more than 100,000 shares ($1.2m worth) and even then there is a clause allowing them to settle your request in cash.
  • An advantage for ETF’s is you can employ leverage with options – but then that of course introduces risk not available with bullion.
  • Stating the obvious, but ETF’s introduce counterparty risk.  As they put it: “While gold ETFs can be a fine investment, they come with a lot of counterparty risk inherent in their chain of custody. And this risk will only grow commensurately with systemic uncertainties.

Think about it: If you own GLD, you must rely on a counterparty to make good on your investment. If the fund’s management, structure, chain of custody, operational integrity, regulatory oversight, or delivery protocols break down, your investment is at risk.”

  • Breaking down that chain of custody – “When you invest in GLD, you buy shares through an Authorized Participant, which is usually a large financial institution responsible for obtaining the underlying assets necessary to create ETF shares.

When it does so, it is buying shares in the fund’s trustee, the SPDR Gold Trust. The trustee then uses a custodian (HSBC) to source and store the gold for it.”  To make it worse there is also the use of ‘Sub Custodians’ which HSBC can outsource to, adding yet another layer of counterparty risk.  But it would be all underwritten yeah?... 

  • “There are no written contractual agreements between sub-custodians and the trustees or the custodians, which means if a sub-custodian drops the ball, the ability of the trustee or the custodian to take legal action is limited.

This leaves the trustee on the hook for any negligence. But trustees don’t insure the gold for gross negligence; they leave that to the custodian, who secures limited general insurance coverage for the contents of the vaults. The value of the gold in the vaults is likely to be much greater than this limited policy would cover.

What this all boils down to is that if anything happens to any of the counterparties, you’re the one who loses. And you have zero recourse.”

  • But HSBC is one of the world’s biggest banks so you should be in safe hands, right?
  • “Here’s a look at HSBC’s Rap Sheet:
    • fined $1.92 billion for violating laws designed to prevent money laundering and other illegal financial activity
    • allowed drug traffickers to launder billions of dollars in the US, and billions more across borders to countries facing sanctions, including terror-ridden Libya
    • admitted to gross violations of the Bank Secrecy Act, including failure to establish and maintain an effective anti-money-laundering program, failure to establish due diligence, and involvement in the laundering of over $881 million
    • accepted $15 billion in cash across the bank’s counters in Mexico, Russia, and other countries
    • paid a $275 million penalty to settle with the Commodity Futures Trading Commission for manipulation of benchmark rates used in the foreign exchange markets
    • fined $470 million for abusive mortgage practices during the 2008 crisis
    • faces criminal investigations in the US, France, Belgium, and Argentina for helping wealthy clients across the world evade hundreds of millions of pounds worth of taxes”

As we wrote last year ETF’s are not a ‘free ride’ either.  GLD comes at an annual cost of around 0.4% plus you have brokerage fees in and out.  You don’t need to hold gold for long before the buy/sell spread for physical becomes cheaper than holding an ETF.  But to be frank, this is semantics as we are talking about protecting your wealth in an event that could see financial markets fall over 50%.  As for physical gold lets leave with that article’s thoughts:

“Gold funds like the GLD ETF clearly don’t offer the level of safety people expect, especially during times of economic downturn or other financial turmoil. This is why serious investors who are looking to put protections in place for their portfolios prefer gold bullion.

Gold bullion refers to specific pieces of physical metal held in your name and title. It is not a paper proxy for gold, but the real thing—and you own it outright.

When you own gold bullion, you can never suffer a default. There’s no counterparty to make good on a paper contract. Once you buy gold bullion, it’s yours, and it doesn’t require the backing of any bank, government, or brokerage firm.

Physical gold offers advantages that GLD can’t. In addition to hedging risk, gold also has specific physical attributes that make it highly valuable, and is an excellent wealth and portfolio diversifier. No other asset has all of these intrinsic financial traits.”