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With a seemingly endless stream of macroeconomic risks coming down the pipeline every day whether it is the risk of currency devaluation, sovereign debt defaults, bond market collapses, or the ever-present "fiscal cliff" it’s no wonder that investors have turned to the safety of precious metals.
And for good reason: Someone who bought one ounce of gold in July of 2010 would have gotten a return of 32%. Those who bought a year earlier would have raked in 69.2%. And gold investors who bought during the darkest days of the financial crisis would have realized a whopping 77.6% gain.
Using exchange-traded funds, like the SPDR Gold Shares (GLD), is a popular way to add gold exposure to one’s portfolio. Since GLD shares are backed by physical gold, many investors are under the impression that they can redeem them for the actual metal at any time but is that really true?
We did some digging into GLD’s 10-K a comprehensive summary report of a company’s performance that must be submitted annually to the SEC and found some interesting facts that we believe every GLD investor should know.
Here’s a hint: Unless you own more than $16 million worth of GLD shares, don’t expect to be redeeming them in physical gold anytime soon.
But first, let’s go over some background information on how an ETF is structured.
Many investors prefer ETFs as a way to spread out market risk across multiple companies and indices. For example, an investor would be better off buying an ETF like SPY, which tracks the S&P 500, than buying every S&P 500 stock individually. In short, ETFs lower transaction costs by issuing shares in lots known as "baskets" for a corresponding quantity of the designated assets.
Most ETFs are organized as trusts. The company that starts the process usually called the "sponsor" bears all the legal and other costs of forming the trust. These include dealing with the SEC, selecting the "Trustee" and the "Custodian," issuing the first fund shares, and depositing an initial tranche of the designated assets (in the case of GLD, physical gold) with the custodian.
GLD’s sponsor is World Gold Trust Services (WGTS), which is owned by the World Gold Council (WGC), an industry marketing organization funded by gold-mining companies. BNY Mellon Asset Servicing is GLD’s trustee, and HSBC Bank USA is the custodian. As the custodian, HSBC keeps track of and stores all of the gold that backs GLD’s shares.
Currently, HSBC’s vaults contain more than 41.3 million ounces of gold, secured safely beneath the streets of London. According to the company, gold held by the trust is not traded, leased, or loaned under any circumstances, and no additional shares can be produced by cash or derivative contracts. Each share represents about one-tenth of an ounce of bullion at current market prices. But the question most important to many gold bugs is "How can I redeem my shares in physical gold?"
For most investors using GLD, this is a difficult and nearly impossible process.
Fact #1: In order to qualify to redeem your GLD shares in physical gold, you need special permission from SPDR, which is typically reserved for brokers and market-makers like Goldman Sachs and JPMorgan Chase.
Fact #2: Shares can only be redeemed in batches of 100,000, which is equivalent to 10,000 gold ounces (a little over $16 million at today’s market price).
Fact #3: To add insult to injury, deep inside GLD’s 10-K we found that the fund retains the option to redeem gold requests in cash rather than the physical metal. Translation: Even with $16 million in GLD, you still might not be able to receive your physical gold upon request.
And there’s more: since GLD is structured as a grantor trust, investors don’t pay taxes similar to regular ETFs.
Fact #4: As a GLD investor, you pay taxes on the underlying asset in this case, gold. Gold, however, is taxed as a long-term holding at a rate of 28% instead of the 15% capital gains tax you would pay on other equities. That can certainly eat into your returns.
At least, according to GLD spokesman George Milling-Stanley of World Gold Trust Services, the fund is truthful about its gold holdings. Many wonder how GLD is able to procure so much gold in the first place. But, Millings-Stanley states, the process is easier than you would think: nearly all the gold comes from another part of the HSBC vault.
HSBC’s vault which he claims is "about the size of a football field" holds both the gold of many of HSBC’s clients and GLD:
"HSBC stores both allocated and unallocated gold. When the trust (GLD) issues new shares, the metal to back them comes from clients of HSBC, who have unallocated pool gold stored with the bank and are willing to sell at the price offered. Once the authorized participant completes the transaction, the gold is moved from the unallocated section of the vault to the area assigned specifically to us (GLD). Occasionally, gold will have to come from outside of HSBC, but there’s always been sufficient bullion available from other London vaults. So transport isn’t a problem, and the market maintains a very careful chain of custody."
For those skeptical that GLD actually has the gold it claims to have in its vaults, he says to check the serial numbers, refiner name, fineness, and weight of every bar, which is updated and posted every Friday on the company’s website. He also points to independent audits conducted by Deloitte & Touche, but confesses that the firm does not count each individual bar. Rather, they certify the "adequacy of accounting procedures."
For those of us who enjoy the safety and protection offered by physical gold, GLD can have its gold holdings audited until the cows come home. It still doesn’t change the fact that only a select few of GLD’s institutional investors can redeem their shares in physical gold when the time comes. If you are simply looking to ride the price of gold, go ahead and use GLD as a proxy just don’t confuse ownership of shares with ownership of metal.
Remember that physical gold is the only real weapon against governments devaluing their currencies and the runaway inflation that comes with it. Gold has been used as money for thousands of years and has historically always maintained its purchasing power, even in times of hyperinflation when paper currencies became worthless. Case in point: In the 1930s, when gold was trading at $35 per ounce, you could have bought a good-quality suit for a one-ounce coin. Today, at a price of around $1,600/oz, you can still get a good-quality suit for one ounce of gold. Try to do the same with 35 of your 1930s paper dollars.