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Nadeem Walayat Financial Markets Analysiis and Trend Forecasts

Risks of Investing in GLD ETF

Commodities / Gold & Silver 2009 Feb 22, 2009 - 07:41 AM GMT

By: Eric_deCarbonnel

Commodities Diamond Rated - Best Financial Markets Analysis Article1) GLD does not allow redemptions of its gold bullion

GLD failure to allow redemptions in gold is suspicious. In fact, only two gold ETFs worldwide allow redemptions in gold, and both of them are located in Switzerland: Gold ETF from Zurich Kantonalbank (ZKB) and Julius Baer (JBGOUA).


Michael Pennington makes this point effectively in his article WHY I BELIEVE THE GOLD AND SILVER ETF'S ARE SCAMS :

“The most important aspect investing in gold and silver is to take possession of your physical metal. When these ETF's were created, they made it impossible for any investor to take possession of their gold or silver. This should be a major red flag alone.”

2) GLD created and run by untrustworthy institutions

JP Morgan, HSBC, and the rest of Wall Street's big financial institutions have given us:

A) A 50+ trillion credit-default-swap market (which threatens to destroy the world's financial system)
B) Subprime CDOs squared (taking worthless subprime loans, adding leverage, and selling it to investors as AAA-rated security)
C) Auction rate securities (investors were sold billions of these “as-good-as-cash” securities, and then the market for auction rate securities collapsed last year)
D) synthetic CDOs (credit-default-swaps were sold and packaged into investment vehicles called synthetic CDOs)
E) CPDOs (credit-default-swaps were sold, leveraged up 15 to 1 , and then packaged into investment vehicles called "constant-proportion debt obligations")
F) CDPPs (credit-default-swaps were sold, leveraged up 80 to 1 , and then packaged into investment vehicles called "credit derivative product companies". Read more )

Aren't you the least bit curious what horrors these same institutions have been doing to gold markets? Will GLD turn out to be as “safe” as all the rest of Wall Street's AAA-rated junk?

Michael Pennington further explains the issue:

“The gold and silver ETFs were created by such financial giants as JP Morgan and Barclay's Bank that also serve as custodians and sub-custodians. These are the very firms that have been involved in the process of short selling gold and silver in huge quantities. That they would be involved in creating the ETFs had to be considered as most unlikely unless they had nefarious purposes.”

3) GLD's gold is located in London, where most the world's gold leasing occurs.

If GLD wanted to inspire confidence in its gold holdings, it choose the wrong location to store its gold. London has a historic role as the market of choice for central banks' efforts to suppress gold prices. The fact that much of the world's gold leasing occurs in London only adds to the uncertainty around GLD. From the SPDR Gold Shares Prospectus :

allocateD GolD: The Trust's allocated gold bullion is kept in the form of London Good Delivery bars (400 oz.) and held in an allocated account.
Storage: The gold bullion is held by the Custodian, HSBC Bank USA, in its London vault or in the vaults of sub-custodians.

4) Reading the Prospectus shows how GLD is loaded with counter-party risks.

I recommend GLD investors re-read its perspectus, as the ETFs loose legal framework and counterparty risks are clearly outlined. The SPDR Gold Shares Prospectus states that GLD ”is subject to a number of risks and uncertainties, including, but not limited to:”

  • fluctuations in the price of gold;
  • reductions in the amount of gold represented by each Share due to the payment of Trust expenses and the impact of the termination of the fee reduction under the Trust Indenture;
  • purchasing activity in the gold market associated with the purchase of Baskets from the Trust;
  • the lack of experience of the Sponsor and its management in operating an investment vehicle such as the Trust; unanticipated operational or trading problems;
  • the lack of protections associated with ownership of shares in an investment company registered under the Investment Company Act of 1940 or the protections afforded by the Commodity Exchange Act of 1936;
  • the lack of a market for the Shares;
  • the level of support from the World Gold Council;
  • competition from other methods of investing in gold;
  • the impact of large-scale distress sales of gold in times of crisis;
  • the impact of substantial sales of gold by the official sector; the effect of a widening of interest rate differentials between the cost of money and the cost of gold;
  • the loss, damage, theft or restrictions on access to the Trust's gold; [restrictions?]
  • the lack of adequate sources of recovery if the Trust's gold is lost, damaged, stolen or destroyed, including a lack of insurance;
  • the failure of gold bullion allocated to the Trust to meet the London Good Delivery Standards;
  • the failure of sub-custodians to exercise due care in the safekeeping of the Trust's gold; [ie: leasing out gold (which is allowed per perspectus)]
  • the limited ability of the Trustee and the Custodian to take legal action against sub-custodians; [GLD is designed to protect sub-custodians from the legal action which losses on their gold leasing activity would trigger]
  • the insolvency of the Custodian; [As noted in GLD's prospectus, we know “Gold held in the Trust's unallocated gold account and any Authorized Participant's unallocated gold account will not be segregated from the Custodian's assets. If the Custodian becomes insolvent, its assets may not be adequate to satisfy a claim by the Trust or any Authorized Participant.]
  • the Trust's obligation to reimburse the Purchaser and the Market Agent for certain liabilities in the event the Sponsor fails to indemnify them;
  • competing claims over ownership of intellectual property rights related to the Trust;
  • other factors identified in the “Risk Factors” section of the Prospectus filed with the SEC and in other filings made by the Trust from time to time with the SEC.

5) GLD's gold is not audited

As an accountant, I find the lack of audits of GLD's gold bullion inexcusable. How are we supposed to know the gold is actually there?

6) GLD can be sold short

Allowing GLD to be sold short dilutes the gold-backing of each ishares. Also, when GLD is sold short, it undermines the arbitrage process on which all ETFs are based (see how an exchange-traded fund works ).

Michael Pennington explains:

The SEC allows shorting selling of these funds which is a fraud itself. So is naked short selling which will be rampant in any commodity-based scam like this. Currently, there are over 10 million shares short in GLD [it's now 14 million] and this does not count the naked shorts since they are not required to declare. That means that there are at least 10 million shares owned by longs which have no physical gold backing them in the vaults of the GLD custodian.

7) GLD is at risk of confiscation


Metals bought from the government-backed financial institutions have an especially high risk of confiscation.

8) GLD is used to sell gold futures

To add insult to injury, GLD ishares are used to sell gold futures and drive down the price of gold. Investor Village explains about this practice :

bullion separately may be deposited and redeemed by "Authorized Participants" for Ishares that never even reached the Retail Market. There is no trust requirement for an Authorized Participant (read specified Bullion Banks and most likely friends) to even sell the ishares (GLD) (received on deposit) into the Ishare market. The Prospectus specifically states that.

Significantly, the depositors ("Authorized Participants") have the alternative of using the Ishares (GLD) as collateral for setting up a spread at the COMEX, by selling Gold futures short against the Ishares they hold.

Such gives the bullion depositor ("Authorized Participant") the ability to make profit at a "Commodity" taxable rate rather than a higher "collectible" tax rate,
which was adjudged to be applicable to GLD. The Prospectus specifically acknowledges that the Authorized Participants may be engaged in bullion trade and have trading desks.

As to the question of whether the gold will be there, the lingering doubt of the potential for "double counting" may exist.

In other words, “Authorized Participants” can deposit gold with GLD's custodian (where it is leased out) and then use GLD ishares to sell gold futures (at an attractive tax rate).

9) GLD has never had storage issues

When the gold holdings of Zuercher Kantonalbank's ZKB Gold ETF reached just 75 tons, the Zurich-based bank was forced to look for more gold storage space because its vaults were full. Straight Stocks report about this lack of gold storage space :

“Zuercher Kantonalbank, the Swiss lender that manages about $107 billion, said its gold vault is full after a surge in demand from investors seeking a haven during the credit crunch.

Assets in the Zurich-based bank's ZKB Gold ETF, backed by about 2.66 million ounces of the metal, have risen to a record for seven consecutive weeks. That amount of gold is worth about $2.25 billion at today's prices and equal to about 12 days of global production.

“Demand is so strong,” Susanne Toren, a metals analyst at the bank, said by telephone from Zurich today. “Our vaults are full right up to the top.”

Investors are buying gold coins and bars, and exchange- traded funds backed by physical metal, after banks including Lehman Brothers Holdings Inc. collapsed. Assets in SPDR Gold Trust, the largest ETF backed by bullion, advanced to a record 770.64 tons (24.78 million ounces) on Oct. 10.

Zuercher Kantonalbank, which is owned by the Canton of Zurich, also manages funds for silver, platinum, and palladium. Sibylle Umiker, a spokeswoman for the bank in Zurich, confirmed the vault is full and said the company “is looking for more space in Switzerland.”

In contrast to the swiss ETF, GLD has accumulated over 1000 Tonnes of gold without ever experiencing storage problems.

10) Where does GLD get its bullion?

Similarly to the storage issue, there is little evidence of GLD's supposedly massive gold purchases in the physical gold market. As a result, I share GATA concerns over where the gold ETFs get their bullion :

The failure to unearth the Madoff scandal earlier becomes incredible when one understands that the returns from the market that were claimed on the size of the hedge fund were logically impossible.

The same reasoning screams bloody murder when applied to the many gold EFTs in terms of what it is they really own.

This raises a major question: From where did all the gold claimed to be owned by all the gold ETFs come from?

Where did funds such as GLD get their additional 45 tons in the last month?

We certainly can forget about that gold coming from the Comex. Twelve deliveries would stand out like a sore thumb.

Record keeping eliminates all exchanges around the globe as the source of bullion in any size to all the gold ETFs.

The physical market is so tight that coin minting has all but closed down compared to what it was one year ago. It is hard to accept that the gold EFTs can buy what the mints can't.

Conclusion: The central point to owning gold is safety, and GLD is not safe. The only gold ETFs I recommend are those in Switzerland which are redeemable for physical gold.

By Eric deCarbonnel
http://www.marketskeptics.com

Eric is the Editor of Market Skeptics

© 2009 Copyright Eric deCarbonnel - All Rights Reserved
Disclaimer: The above is a matter of opinion provided for general information purposes only and is not intended as investment advice. Information and analysis above are derived from sources and utilising methods believed to be reliable, but we cannot accept responsibility for any losses you may incur as a result of this analysis. Individuals should consult with their personal financial advisors.

Eric deCarbonnel Archive

© 2005-2019 http://www.MarketOracle.co.uk - The Market Oracle is a FREE Daily Financial Markets Analysis & Forecasting online publication.


Comments

jim
17 Mar 09, 15:23
ETF's

this article is bogus, do more research


Ben
02 Mar 10, 12:08
Errors

Mr. DeCarbonnel is correct on the redemption issue but incorrect several points. The most important point I want to correct is that GLD is audited. Their annual report is audited by Deloitte & Touche LLP. It's on their 10-K filed in Nov 09.

Also prospectus is not spelled "perspectus".


Michael Pennington
29 Oct 10, 23:42
Michael Pennington

The link which quotes me is no longer valid. If you would like to read the actual article you can find it at http://penncocoins.wordpress.com

Thank you,

Michael Pennington


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