By the Hard Assets Alliance Team

Well, duh, of course not.

That might be your response to the question, and you would be quite right. Yet millions of investors are behaving as if a piece of paper – or, more accurately, the electronic representation of same – is the equivalent of a bullion bar. Such is the enormous popularity of the SPDR Gold Trust shares (GLD) traded on the NYSE Arca exchange.

It’s a little bit like this: Suppose you’re selling your car. A guy comes by and offers you ten ounces of gold for it. That’s a good price. Sure, you say. But when the day comes to complete the transaction, the seller hands you a piece of paper on the local coin shop’s letterhead and tells you it’s worth ten ounces of gold, all signed and notarized and everything. All you have to do is take it down to the shop and cash it in. Oh, you say, and then I get my ten Maple Leafs? Well, no, he says. You see, the shop owes me ten ounces of gold, but they don’t have to repay it in coins. So what they’ll actually give you is the equivalent in cash. OK?

The metaphor isn’t exact, but it’s close enough for government work.

Paper gold vehicles were set up for those who would like to book paper profits from the metal’s ongoing bull run but are unwilling or unable to take physical possession. GLD, by far the largest and most popular of these at the moment, is one of several exchange-traded funds (ETFs). ETFs are traded like stocks on the major exchanges, with shares issued and redeemed in line with gold bullion stored in the company’s vaults. Shares attempt to track the spot gold price day to day with, in GLD’s case, one share equivalent to the value of slightly less than one-tenth of an ounce (.097 at this writing).

There are also precious metals closed-end funds (CEFs), the most prominent of which is Central Fund of Canada (its ticker symbol is, a little confusingly, also CEF). Shares of these trade on stock exchanges and are very liquid. The difference between them and ETFs is that CEFs merely buy and store bullion. The amount doesn’t change unless they want to add more; then they sell more shares and buy metal with the proceeds. Consequently, the price of a CEF doesn’t mimic the gold price – it isn’t designed to. It’s an expression of demand, so that in times when gold is popular, the CEF’s price is generally at a premium to the net asset value (NAV) of what’s in the vault. If gold tumbles, then the CEF could sell at a discount to NAV.

CEF shares can’t be swapped for precious metals. GLD shares can be… at least theoretically.

In reality, however, it’s impossible for any but the very well-heeled investor. The minimum that can be redeemed is one “Basket,” which is defined as 100,000 shares. That means you would have to pony up enough money to buy 10,000 ounces of gold – around $16 million at current prices.

Moreover, the company reserves the right to postpone, suspend, or reject redemption orders for a number of reasons. Among them, according to the company’s prospectus, is suspension “for any period during which an emergency exists as a result of which the delivery, disposal or evaluation of gold is not reasonably practicable,” and “for such other period as the Sponsor determines to be necessary for the protection of Shareholders.”

That seems to mean that, even if you meet the minimum requirements, the gold may not be there when you want it.

And if it is, there will be less of it than what you were expecting. As the prospectus states, “The number of ounces of gold required to create a Basket or to be delivered upon the redemption of a Basket gradually decreases over time, due to the accrual of the Trust’s expenses and the sale of the Trust’s gold to pay the Trust’s expenses.” (GLD’s target expense ratio is 0.4% per year.)

GLD, along with other ETFs and CEFs, is convenient, no doubt about it. With a few clicks of the mouse, you instruct your broker to add shares to your portfolio, just as you would with Apple or Microsoft. It’s a hassle-free and very liquid transaction. When you want to sell, you can do so just as quickly and cleanly – although what would happen if there’s a sudden, steep decline in the price of gold is unknown, since it’s never happened.

But clearly, this is a vehicle for those who want to buy paper in order to turn a paper profit. It is not a way to buy gold.

What can you do if you want to own physical gold that is stored in a secure, offsite or offshore location?

There are a number of possibilities, including pooled gold accounts and certificate programs. Each has its pros and cons. In the case of a pooled, unallocated account, the vault is always supposed to have access to enough gold to fully cover a forced liquidation. That’s all well and good, but one would think there has to be a pretty big incentive to cheat a little, since the assumption would be that all the account holders are not going to want their metal at the same time. It’d also be tempting to lend out some of the gold – in fact, some institutions may specifically reserve the right to do this. And having title to unallocated gold makes you an unsecured creditor of the holding institution, rather than an outright owner.

via Worldwide Precious Metals Exchange | Can You Spend Your Paper Gold?.


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