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Guest Post: Tracking Gold
Submitted by Doug Hornig of Casey Research
Tracking Gold
Recently, we’ve received a number of emails from readers asking why the primary gold ETF, SPDR Gold Trust (NYSE:GLD), doesn’t more closely track the price of gold, and other related questions. For those readers who aren’t already familiar with the workings of this innovative way to “own gold,” it’s worth going over a few of the details, because there are some common misunderstandings regarding the ETF.
The creators of GLD were as savvy as it gets. They saw a market crying for something like this and turned that need into one of the most successful new financial products ever introduced. The ETF burst upon the scene in November of 2004 and was immediately latched onto as a means of riding the gold bull market without the inconvenience of having to transport and securely store actual bullion. In the past seven years, its rise has been meteoric. It has steadily ascended the list of the world’s leading gold repositories, until today it has the sixth-largest global stash of the metal, at more than 1,230 tons, or 39.57 million ounces, worth over $70.7 billion.
First misconception: Contrary to popular opinion, the SPDR Gold Trust does not buy and sell gold. It creates and redeems paper shares in the company. These are passed through a group of market makers, who trade them on the NYSE, then deposit into or withdraw from the HSBC vault in London the corresponding amount of physical bullion, in the form of 400 oz. London Good Delivery bars.
And even that description is somewhat misleading. GLD deals only in “baskets” of 100,000 shares, with the goal being for the share price to track gold’s market value as closely as possible. Since each share represents slightly less than a tenth of an ounce of gold, that means each basket must trade close to 10,000 ounces of gold. That’d be impractical if the buying and selling had to be done on the open market.
So how do they pull it off? Well, the company is not exactly forthcoming about its inner workings, but after extensive conversations with officials, I was able to determine that what actually happens is that the gold is moved either into or out of the GLD-allocated section of HSBC’s vault, to or from another section of that same vault. When I found that out, I envisioned a guy on a yellow forklift, driving pallets laden with thousands of ounces of gold back and forth across the vault floor. Such a job.
Beyond the basics, we don’t know much. You will not be allowed to see the vault, whether or not you are a GLD shareholder and no matter how many shares you own. In fact, a high trust official in New York told me that even he isn’t allowed inside there.
For the most part, GLD does a pretty good job of following the spot price of gold. A share will never be priced exactly at the value of a tenth of an ounce of metal, simply because the trust deducts transaction fees and other expenses. But it’s close. During August of 2011, for example, the net asset value (NAV) of a share of GLD varied from 97.3635 to 97.3867% of the gold price, as fixed each day at 10:30 a.m. New York time.
However, if you are an investor in GLD, or are considering becoming one, there are a few things to keep in mind. First of all, it can’t be stressed enough that this is a paper asset. It is not a way to buy gold and have someone else store your holdings for you. That can be done in other ways. There are depositories that specialize in this service, both domestically and in foreign jurisdictions like Switzerland. But that isn’t what GLD is about.
Now, theoretically, it is true that you can convert your GLD shares to physical gold and take delivery of it. But practically, you can’t. For one thing, you have to be approved to do so (generally meaning, you’re either a broker or a market maker), and then you have to redeem a minimum of 100,000 shares. And even if you meet those qualifications, buried in the firm’s prospectus – a very tough read, by the way – is a provision stating that they have the option of redeeming such shares in cash equivalent rather than bullion.
This is to say: If there is a sudden run on physical gold, GLD is not contractually obligated to provide actual metal, in exchange for however many shares, to anyone.
Thus our position has always been: Hold as much gold in coins and bullion as you comfortably can. Use the ETFs to generate profits if you like, but make sure you realize that all of those profits will be of the paper variety.
Furthermore, there is the little matter of taxation. You may well understand that GLD shares are not a substitute for precious metals, and you may be in it only as a way to make money from a rising gold price by simply placing an order with your regular stock broker. If so, well and good. But what you may not know is that GLD shares, although they trade like stock, are not stocks in the same sense as Apple shares. Not when the taxman cometh.
If you buy shares of Apple and hold them long term, for more than a year, then sell them, you are taxed at the prevailing capital gains rate, currently 15%. Gold, however, is considered a “collectible.” If you buy gold coins, for example, and hold them long term, then sell them, your tax liability is at the rate for collectibles, presently 28%. If you sell them for a short-term profit, you’re liable for taxes at the same rate as for ordinary income, which is determined by whatever bracket you’re in.
Of course, GLD shares are not gold, as I’ve just taken some pains to point out. Ah, but here’s the rub. GLD is structured as a grantor trust, not a mutual fund. A grantor trust is ignored for tax purposes so that the investor is treated as owning a pro-rata share of the underlying holdings, not the entity as it exists on paper. That is to say, if GLD were a mutual fund, shares would be taxed at the normal capital gains rate, but because it is a grantor trust, its long-term gains are taxed at the applicable rate for the gold it holds… which is 28%.
This situation leads to some rather odd tax peculiarities. Say your ordinary income is in the 25% tax bracket. You’re actually better off selling GLD shares short term than you would be if you held them long term and got pushed into a 28% liability.
None of this is to disparage GLD. For ordinary investors, the ETF represents a way to (indirectly) participate in gold “ownership” without the hassle of actually taking physical delivery and finding a suitable place to vault your metal. Plus, there are no storage fees, bid/ask spreads, threats of theft, or dealer markups to worry about. And finally, for those who like to really play the market, shares are amenable to all the tricks of the securities trade. They can be optioned, shorted, hedged, bundled, margined, whatever. Little wonder GLD is so wildly popular.
So use GLD if you are of a mind to. Just be certain you understand what it is you are dealing with.
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Woah, woah, WOAH - just woah there fella.
Where in the hell can you buy a hot pocket for $.50 ? They're a dollar a pop 'round these here parts.
I wants me some of that!!!
If one buys physical gold/silver, the costs are minimal: there is no terrible spread with monex, or with the Fidelity system I use. I don't need some silly vault to protect my silver and gold, i do it myself in several ways.
Those who buy ETFs are lazy and themselves trying to scam the market; whatever happens to them, they deserve it. They are buying paper, they are not reading the conditions and they think they are getting over.
There is no way on god's earth that ETFs have the gold in their vaults that they have sold. DUH. That is why they have cash payback provisions.
Americans just keep gettin dumber and dumber, as if this is even possible.
What's your address? I'd like to talk about this in person.
Also, what hours will you be away at work?
And having seen the CNBC special, where they actually show the inside of the vaults... there's a sh*t-ton of bullion in there. A massive amount. I didn't count it, but $70B wouldn't shock me.
Yes, a shitload of Gold plated tungsten. WHen Gold hits $50,000/oz and tungsten hits $1800 /oz then I can agree with you my friend.
Now that the European Union successfully forbid the light bulbs, there will be plenty of tungsten available. Guess where it will be used?
Exactly where's was that vault again? Who owns it?? Yeah......
I purchased a gold coin on eBay and got one of those chocolates covered with gold foil.
At least you could eat it.
Touché! LOL. Verte pour vous!
Tyler - you missed the important part! Toward the back of the GLD prospectus you will find somethings that says: We hold gold in foreign Countries where we have not legal system or authority to execute on assets....
In my world that is smoke and mirrors. Good luck if you ownt his ETF!
yamaha @ 17:34,
AND another winner!!!!!!!!!!!!!!!.
"We hold gold in foreign Countries where we have not legal system or authority to execute on assets...."
If anyone believes this CROCK, I surely do have some swampland................
What Honest,Smart, business would dream of allowing multiple millions of dollars of Gold, to be held in ANY PLACE they could not have redress, and legal rights to?.
Sell it somewhere else, Paleeeeeeeeeeeeeeeeeze.........I smell dog doo.
GLD = Good Luck Dude
Not to mention
Gold and Silver Eagles -- No 1099 required!
Got Physical?
A sophisticated trading ponzi, right?
You can probably take delivery of large bullion consignments, but you would be taking delivery of physical only during times when the ETF is divesting. The rest of the players are oblivious to the background appropriation of gold.
GLD and SLV are good vehicles for playing options in the short term. It has worked out great playing puts and calls with the volitility going on in gold and silver. Of course it's all paper but who gives a crap if you can turn some profits into fiat and then into physical.
Maybe I will get caught holding the bag one of these days but I'm going to take as much profit as I can in the meantime. I got no expectations of ever turning GLD shares into physical though them. I will do it through a roundabout way.
Nice story--faulty logic combined with a touching example of your disaster profiteering greed. ( intended reply to $20 hotpocket guy)
i
"the ETF represents a way to (indirectly) participate in gold “ownership” without the hassle of actually taking physical delivery"
Oh what a hassle!
Indeed. + 1
I’ve heard it said that physical gold only holds its purchasing power.
Tell me, did gold just hold its purchasing power when it got confiscated in 1933 or did it get revalued +70%?
How about the decade after the gold window was closed by Nixon?
The gold price multiplied many fold even out doing inflation.
You see it had to because more paper currency existed than gold in reserve.
Today is no different except the currency is no longer backed by gold or is it?
Now all we have that’s different than the days of gold backed currency is a buffer, "the paper market". The price of gold is suppressed to make the currency look good.
This price suppression has been going on for a long time now it’s like a rubber band being stretched and it’s at the point of snapping. We know why only gold will be revalued because 1 it is not an industrial commodity and will not affect industry 2 it is held by all the central banks because it is real money and 3 because it has been revalued before.
So when someone says gold makes no profits just smile and say, that’s what I heard.
Yours in gold,
Badabing
"why the primary gold ETF, SPDR Gold Trust (NYSE:GLD), doesn’t more closely track the price of gold"
Why you think Gold will never go down and it's a "sure" thing?
Every f* body so sure that Gold should just
go straight up to whatever 5k, 10k and beyond.. I'm thinking are
you guys completely idiots or what? Or just partially? :)))
Would you think if that was so easy, then why we need everything
else then? Just buy stupid Gold and go sleep for few years..
Fools!!! Market will teach you a lesson, always will and always
does.. Just wait and see..
Yes, the market always teaches a lesson to those who speculate using leverage, however to we that hold gold as long term insurance against the evil and stupidity of governments are the ones teaching the lessons this go round.
A thing about the PM ETFs that bothers me is that I think that they are one of the reasons that PM equities are dragging ass compared to the PM ETFs. I think that they used to catch a lot more trade and were the normal "go to" if a body couldn't or didn't want to cope with physical. It would be interesting to see some egghead do an analysis of the price and market cycle behavior both without the ETFs and with them sucking up so much of the PM trade share. I view them as competition for PM equities for the trade dollar. For one thing, the ETFs are easier to play than picking good PM equities although the PM equities can be much more profitable. The PM equities don't necessarily dance to the same music as the PM ETFs since the general equities markets' behavior seems to exercise a stronger influence on the PM equities than the metal ETFs (PM equities ETFs such as GDX and GDXJ also seem to be sympatico with the general markets as one would expect). I also expect the PM equities to have a faster recovery than the general markets under conditions of booming PM markets.
I think I like the good old days when PM equities were the primary alternative to the sundry bullion markets and I think it made for a healthier overall PM trading environment (Yes, Virginia, despite the odd Bre-X grade rip offs!). I fear that one of these fine days some PM investors will be left holding more paper promises via ETFs than an actual equity interest in a PM producer (without trying to open up the can of worms of taking possession of the certs themselves - that's another interesting fooferaw). I'll back away from the soapbox and duck into the foxhole now. FWIW, I've played and made money on both the PM ETFs and PM equities as well as the PM equity ETFs, and I've played in both PM runups.
Doug forgot to mention some stuff, like you can never even actually own GLD shares.
From the prospectus:
Why does this matter? Because with this setup every GLD share can be sold twice. A long sale AND a short sale, and there's nothing you can do to stop them.
When a DTC participant sells GLD shares short, they "borrow" those shares from a long without asking (or telling) and sell them again, meaning two people now "own" the same shares.
Do they have to deposit gold with the trust? Fuck no.
So the actual NAV per share should be HALF the stated value.
Notice that nasdaq.com never shows "short interest" on GLD (or any ETF).
So riddle me this - if DTC participants can sell short the GLD shares of their clients without permission, what does it mean when these ETFs show up on the SEC'S "fail to deliver" list?
Gold $50,000
Gold $1000
Thanks ZH very informative & timely article. Ali
If you don't HOLD IT,you don't own it.!
Normally I find little to quibble with in any of Casey's observations, but to say that holding shares of GLD will protect you from theft is a little much, don't you think? Sure, grizzly bad guys can't slip into your house at night and steal your shares of GLD, but that smiling guy in a suit in NYC or London - you gonna be tiefed mon.
With regards to the paper piece of my PM exposure, I’ve always purchased calls/LEAPS. Any idea how gains on options are taxed? I would hope the tax liability/cap gains rate is not tied to the underlying for gains via derivatives...?
They must think we are idiots?
To "Tyler Durden" from the Zerohedge website regarding the CNBC video released showing the alleged vault holdings of GLD.
"Conspiracy nuts" far and wide have contended that the vault, auditing and custodian processes of GLD are suspect.
It is absolutely hilarious that CNBC would be "allowed' into the vault" with Bob Pisani being blindfolded and stripped of cell phone and any other GPS devices only to be shown holding a Gold bar whose serial number doesn't even show on their "barlist". How sloppy is this? "They know" that the "Goldbugs" are complete conspiracy nuts who have to be shown something in black and white (in this case yellow) that is and can be verified to be believed.
Did they think that 100's if not 1000's of us "conspiracy nuts" wouldn't check the serial numbers shown? We are like a "Sherlock Holmes society" when it comes to this stuff. Coin melt or tungsten and not in good deliverable form? German swaps, Gold with the Russian Czar's stamp on it? True global supply and demand? These are all things that "normal people" take at face value but not us conspiracy nuts! We want and dig for the truth because as time has gone on, more and more the numbers just didn't and now really JUST DON'T add up!
Did CNBC just figure the sheeple would oooh and ahhh looking at some Golden bars?
Did they do this piece because some people have finally gotten smart and are buying physical rather than the ETF and they needed a publicity piece to help divert demand away from the real thing and back into their "thing"?
I could go on and on as many have done about the prospectus loopholes but I won't. All I know is that if your enemy who is already known and admitted to misdealings (HSBC, JPM?), are acting as custodians for holdings that you know they are "short of", do you really want to be involved? Do you want them to safeguard your assets when you already know these markets are fractionally reserved?
Do you really want an entitiy(s) which is short to even be tempted by your "stash" when they are pressed to deliver?
In plain street English "would you put a wolf that hasn't eaten in 7 days in charge of your chicken coop"?
The whole system from top to bottom and side to side is a fraud and is based on a fraudulent currency, the Dollar.
Do you think the issuer of that currency or their minions would ever hesitate one second to eat your eggs or chickens and leave you to go hungry? Very sad to say that you must think and do for yourselves because no one else will. The world has changed and neighbors don't help neighbors anymore just as the government is not "here to help you" especially if you are self sufficient?
Don't wait around to find out whether the Gold or Silver "is really there". Do it yourself, that way you KNOW!
www.lemetropolecafe.com
I remember a time, during the dot.com bubble of 1998 - 2000
when countless of Gold Miners and Exploration companies suddenly became Telecommunication Companies overnight, each one of them Experts in Telecommunication Technology with revolutionary new cutting edge software applications, or so they said...
When the dot.com boom went bust in 2000 all these dot.com Telecommunication Companies changed back into Gold mining exploration companies again, looking for more dumb momo "investors" to take for another ride.
That is what financial Markets are really there for - To part momo fools from their hard-earned cash ...and leave them with nothing but hopium and pipe-dreams instead !
At least that's what is happening out here in the real world..
There is never any short supply of new fools, pipe-dreams and hopium....
"When I found that out, I envisioned a guy on a yellow forklift, driving pallets laden with thousands of ounces of gold back and forth across the vault floor. Such a job."
The entire remaining pillar of the jobless recovery exposed in 2 easy sentences. I hope when this guy is fired he remembers to turn out the lights!
Energy efficiency being key to the "new economy" n whatall...
These Guys get it !!!
Booming gold demand in Abu Dhabi 2011-SEP-01Jewellers in the United Arab Emirates are experiencing difficulties meeting rapidly growing demand for gold bullion. The strong rise in gold prices over recent months did not detract from domestic investors´ willingness to transfer capital into precious metals. On the contrary, locally operating gold traders reported that Abu Dhabi´s demand for 100 gram gold bars has reached new highs. Capital flight into safe havens continues among wealthy and middle-class investors, who fear that the world’s economy may face a double dip recession.
The monetary character of gold and silver makes both precious metals an interesting investment alternative. Paradigms have shifted since the outbreak of the worldwide financial crisis. Wealth preservation, rather than high returns, is now the main goal of investors. Precious metals have seen many different economic systems come and go in the last 5,000 years, while proving to be excellent safe havens. In times of fiat currency debasement and central bank money printing, investors are turning once more to precious metals.
Abu Dhabi´s jewellers have already adapted their business model to new market conditions. Sharply rising gold prices have led to a decline in jewellery demand in the United Arab Emirates, so many local jewellers have started offering gold bars to their clients. At Al Awadhi Jewellery, one of the largest jewellers in Abu Dhabi´s gold Souk, about 30 customers a day ask for gold bars, from 100-gram to 1-kilogram. The prices for these gold products vary between 22,000 dirham (about $6,000) per 100 grams and 220,000 dirham (about $60,000 per kilogram). According to Al Awadhi´s management, the demand for gold bars of these sizes has increased by 60 per cent in the last two months. Demand comes primarily from wealthy and middle-class investors seeking for safe investment alternatives.
These Guys get it !!!
Booming gold demand in Abu Dhabi 2011-SEP-01Jewellers in the United Arab Emirates are experiencing difficulties meeting rapidly growing demand for gold bullion. The strong rise in gold prices over recent months did not detract from domestic investors´ willingness to transfer capital into precious metals. On the contrary, locally operating gold traders reported that Abu Dhabi´s demand for 100 gram gold bars has reached new highs. Capital flight into safe havens continues among wealthy and middle-class investors, who fear that the world’s economy may face a double dip recession.
The monetary character of gold and silver makes both precious metals an interesting investment alternative. Paradigms have shifted since the outbreak of the worldwide financial crisis. Wealth preservation, rather than high returns, is now the main goal of investors. Precious metals have seen many different economic systems come and go in the last 5,000 years, while proving to be excellent safe havens. In times of fiat currency debasement and central bank money printing, investors are turning once more to precious metals.
Abu Dhabi´s jewellers have already adapted their business model to new market conditions. Sharply rising gold prices have led to a decline in jewellery demand in the United Arab Emirates, so many local jewellers have started offering gold bars to their clients. At Al Awadhi Jewellery, one of the largest jewellers in Abu Dhabi´s gold Souk, about 30 customers a day ask for gold bars, from 100-gram to 1-kilogram. The prices for these gold products vary between 22,000 dirham (about $6,000) per 100 grams and 220,000 dirham (about $60,000 per kilogram). According to Al Awadhi´s management, the demand for gold bars of these sizes has increased by 60 per cent in the last two months. Demand comes primarily from wealthy and middle-class investors seeking for safe investment alternatives.
It is my understanding that these statements are not true.
Collectibles are taxed at your ordinary income tax rate UP TO 28% (whereas long-term capital gains are taxed at your ordinary income tax rate UP TO 15%).
Hence, there would never be a reason to prefer a short-term gain in a collectible over a long-term gain. However, one would have a preference for an asset/stock which would be taxed as a long-term gain as opposed to a collectible if their marginal tax rate is higher than the long-term capital gains tax rate.
Excellent points regarding the US taxation of PM capital gains, Riley, that are almost always misinterpreted or misrepresented, much to my chagrin.
Yes, the capital gains on gold and silver are taxed at UP TO 28%, not necessarily at 28%. Not EVERY investor, even here, resides in the highest income tax bracket.
What abot UGL? I know it is paper but is it taxed as a collectable? Is it more stable than GLD?
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