The Problem with GLD and SLV ETFs

The ’sweat of the sun’ and ‘tears of the moon’ are singularly unique commodities. They function as unencumbered equity and function as a presentation currency. For this singular reason they are largely hoarded, not consumed, and serve to protect against despotic government inroads by preventing confiscation through inflation which is a form of taxation without representation.

The ETFs GLD and SLV are commonly represented as being bullion. Accepting this assertion is naive and with potential financially lethal consequences. While GLD and SLV track the relative prices that is where the similarities with bullion end.

On May 20, 1999, Alan Greenspan testified before Congress, “Gold is always accepted and is the ultimate means of payment and is perceived to be an element of stability in the currency and in the ultimate value of the currency and that historically has always been the reason why governments hold gold.”

The ETFs GLD and SLV are not this ultimate form of currency. I will raise only a few essential issues, although there are many.

QUALITY OF GOLD

Gold is a physical substance with a specific definition and is listed as element 79 in the periodic table. Gold is not subject to any risks and serves with complete fidelity only its master. Drafted by securities attorneys usually earning $500+/hour, the GLD prospectus, which is similar to SLV’s prospectus, states, “Investing in the Shares involves significant risks. See “Risk Factors” starting on page 6.” Page 11 states, “Neither the Trustee nor the Custodian independently confirms the fineness of the gold allocated to the Trust in connection with the creation of a Basket [issuances].” Page 12: “In issuing Baskets, the Trustee relies on certain information received from the Custodian which is subject to confirmation after the Trustee has relied on the information. If such information turns out to be incorrect, Baskets may be issued in exchange for an amount of gold which is more or less than the amount of gold which is required to be deposited with the Trust.” There is no assurance that the ‘gold’ held in the ETFs is actually the same gold as defined under the periodic table.

On page 11: “In addition, the ability of the Trustee to monitor the performance of the Custodian may be limited because under the Custody Agreement the Trustee has only limited rights to visit the premises of the Custodian for the purpose of examining the Trust’s gold”. Therefore, it appears that an audit of the actual physical gold is precluded. In other words, ‘Just trust us, the gold is there.’

COUNTER-PARTY RISK

The reassertion of counter-party risk is driving much of the risk in the current markets. Page 10 states, “If the Trust’s gold is lost, damaged, stolen or destroyed under circumstances rendering a party liable to the Trust, the responsible party may not have the financial resources sufficient to satisfy the Trust’s claim.” On page 9, “The Trust does not insure its gold.” Further on page 12, “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. In addition, in the event of the Custodian’s insolvency, there may be a delay and costs incurred in identifying the bullion held in the Trust’s allocated gold account.” Gold is not subject to counter-party risk or in other words the financial ability of a counter-party to pay. Clearly, GLD is impregnated with counter-party risk that may instantly and violently appear from within like the Alien.

CONFLICT OF INTEREST

There is economic incentive for the Custodians to loot the ETFs. From page 9, “Under the Custody Agreements, the Custodian is only liable for losses that are the direct result of its own negligence, fraud or willful default in the performance of its duties. Any such liability is further limited, in the case of the Allocated Bullion Account Agreement, to the market value of the gold held in the Trust’s allocated gold account with the Custodian, or the Trust Allocated Account, at the time such negligence, fraud or willful default is discovered by the Custodian”. Not only does the Custodian attempt to disrobe itself of liability, but even if it is found liable it tries to assert damages accounted at the time of discovery of the default. The probability of such damages being woefully understated relative to the potential future market value in the event of such a default is extremely high. In effect, this provision gives the Custodian a perpetual call option on the GLD hoard.

Who are these parties that say, ‘Just trust us, the gold is there’? Page 36 lists some Authorized Participants including such venerable, safe and secure Wall Street behemoths as Bear Stearns & Co. Inc., Lehman Brothers Inc., Citigroup (C) Global Markets Inc., Merrill Lynch (MER), Goldman Sachs (GS), J.P. Morgan Securities (JPM), UBS Securities (UBS) and Morgan Stanley & Co. (MS). Given the past actions of these firms, I am not sure I would want them anywhere near my gold.

For example, in June 2007 Morgan Stanley & Co. settled a class action lawsuit for $4.4 million where the complaint alleged ‘that Morgan Stanley told clients it was selling them precious metals that they would own in full and that the company would store. But Morgan Stanley either made no investment specifically on behalf of those clients, or it made entirely different investments of lesser value and security.’ While the efficacy of the claim may still be at issue the Better Business Bureau-like complaint from unsatisfied customers who initiated litigation does not inspire confidence for those seeking to reduce risk.

During a credit contraction and liquidity crisis the ‘relationship goes out the window’. On December 12, 2008 UBS ‘UBS AG announced today it has frozen one of its real estate funds until the end of next year, due to an inability to keep up with redemption requests from wealth management clients.’ Why? The spokeswoman said, ‘We closed the fund temporarily for the protection of the investor’. It would be most unfortunate to have one’s gold in the sticky fingers of such fine and upstanding firms that refuse to deliver to protect you.

Additionally, the GLD and SLV hoards may pose a convenient source of bullion for the United States government to steal. Given prior tyrannical history with FDR’s Executive Order 6102 this may be a material threat. On the other hand, Section 19 of the 1792 Coinage Act stated that those who ‘debased or made worse as to the proportion of fine gold or fine silver therein contained … shall suffer death’. Perhaps the Americans were more civilized than their French counterparts and preferred the appearance of due process of law when executing their bankers and politicians for destroying their economies with fiat currency and fractional reserve banking.

ACCOMPLICES TO CENTRAL BANK GOLD PRICE SUPPRESSION SCHEME

During the 1990’s Mr. Rubin had devised the gold leasing scheme with the intent being elucidated by Dr. Greenspan’s testimony in 1998, “Nor can private counterparties restrict supplies of gold, another commodity whose derivatives are often traded over-the-counter, where central banks stand ready to lease gold in increasing quantities should the price rise.” Many of the previously mentioned firms are alleged by GATA to be complicit players in the central bank gold price suppression scheme. Mr. Robert Landis, a graduate of Princeton University, Harvard Law School and member of the New York Bar, has asserted that “Any rational person who continues to dispute the existence of the rig after exposure to the evidence is either in denial or is complicit.” Is it possible that GLD and SLV hoards are being surreptitiously used to continue the gold price suppression scheme?

CONCLUSION

For those desiring to trade paper gold, the GLD and SLV vehicles may satisfy those requirements. But for those who desire the ’sweat of the sun’ or ‘tears of the moon’ in order to own the ultimate form of payment and therefore hearken to Chicken Little’s warnings and protect their assets then the GLD and SLV vehicles appear extremely deficient. Alternative forms of holding allocated gold bullion exist that are affordable, secure, convenient, trustworthy and not subject to counter-party risk.

For these reasons including (1) the quality of the gold is at issue, (2) no audit of the physical metal is permitted, (3) counter-party risk impregnates the investment vehicle and (4) there are strong conflicts of interest with complicit players in the central bank gold price suppression scheme; GLD and SLV appear impotent in reducing inflation or counter-party risk.

Disclosures: Long physical gold. No position in GLD or SLV.

Comments

[hendi_alex:]

"Gold is not subject to any risks and serves with complete fidelity only its master."

What about risk of theft, risk of confiscation, risk of being counterfeit or less that stated purity. Risk of "failure to deliver" after bullion has been paid for. What about lost opportunity risk. What about risk of lossing value versus currency value. [Gold not subject ot any risks.] Hmmmph!!!!

2008 Dec 14 10:48 AM

[Top Gun:]

Bad article. Unless you buy the gold and put it in your house, you have counter party risk. Safe deposit - bank could be closed. Own part bullion held by another, they could have a problem. Nothing is risk free, with GLD you trade liquidity for a tad bit more risk. The issuers are highly thought of, so use GLD to increase your gold exposure by maybe 5x over what you would want to hold in physical. That IS an inflation hedge, the physical gold is an armageddon hedge.

2008 Dec 14 11:00 AM

[Trace Mayer:]

Hendi_alex, you are broadening the issue outside the scope as asserted in the article. The risks you raise do exist. Although the article does not contain the reasoning because of space it is implied and important to draw the distinction between tangential risks (exchange rate risk, performance risk, etc.) which assets are subject to because of relative valuation, pricing, property law, etc. and inherent risks (counter-party risk, credit risk, payment risk, etc.) which gold is not subject to because of its attributes.

Top Gun, I doubt you understand the definition of counter-party risk and consequently do not distinguish it from performance risk. The key distinguishing element is the financial ability of the counter-party to perform. The other issues are addressed in hendi_alex's answer.

2008 Dec 14 11:24 AM

[MellowGuy:]

The GLD ETF gives me the ability to buy and sell options. Physical gold doesn't give me that ability.

2008 Dec 14 11:26 AM

[NOWHEREMAN:]

Great Article. If there wasn't any risk involved, the GLD prospectus would not contain Disclaimers.

If one understands that there are risks, buying GLD is as safe as buying any gold related ETF, ETN or Gold mining company, all of whom have Disclaimers built into their respective Prospectus documentation.

Most prospective buyers shun the Disclaimers because of the number and complexity of the pages involved. I certainly do. I rely on others to do the work for me:
My broker, perceptions by Market Mavens, the Market itself.

Different Strokes for different folks, IMHO

2008 Dec 14 11:55 AM

[adan:]

these type of articles, as per your initial oct article, can always use a "re-visit"

not because you may or may not be wrong, but simply 'cause it's great to look back, re-evaluate, and adjust as necessary, ie, it's fun and useful

though i disagree re gold's eventual perceived value, and though i agree re gold's probable price retreat during this time of heavy deflation...

i'd mostly, at this point, question your accuracy re central banks' selling off their gold, i had thought this had abated for now, and have read several acct's of china, russia, and others, increasing their gold reserves

and finally, as an insurance, any insurance, that one hopes never to use, and otherwise seems a waste to spend on, why is it the united states has always maintained its lead in % of gold kept?

in a spot peak crisis, missiles and gold do speak to the world, strongly, in a language clearly understood by all, in regard to any "backing" our country may need

either way, looking fwd to your other follow ups on this topic

interesting stuff, thank you :-)

2008 Dec 14 12:27 PM

[globalHOBBIT:]

I find your analysis of these precious metal ETFs right on the mark. I have read the prospectuses of both these funds and find the disclaimers frightening. Why are independent spot inventory inspections limited, in the legalese of the prospectus, the managers don't have to show anyone they have what they say they have. Why is it that only a court order can compel the fund managers to open the vault(s) to verify the quantity and quality of these funds stated holdings? Anyone who argues with the authors findings probably has NOT read the prospectus fully for these funds. These funds do have a purpose as some of the other comments have stated and they are valid hedges and trading vehicles. However most people who buy these two funds in particular believe they are getting 100% 99.9999% fine gold or silver and that simply isn't the case. My point is read the prospectus fully before making the investment so you understand exactly what you're getting and what you're not getting and even what you might not get. Gold's periodic symbol is AU and when you buy GLD, gold's exchange traded ticker symbol your not getting identical twins, for that matter you may not even be getting fraternal twins but rather second or third cousins twice removed.

2008 Dec 14 12:44 PM

[ozzy43:]

The author raises valid concerns; however, GLD and SLV are within the scope of a 401(k) plan. Purchasing and storing physical metals are not.

The latter would be vastly preferrable, but today, government legislated vehicles like IRAs and 401(k)'s represent the only available investment dollars for most.

In a non-ideal world, the GLD and SLV ETF's have their place, and their risks.

2008 Dec 14 01:12 PM

[slias marner:]

how about cef==a canadian fund that physically stores the gold or silver in calgary canada. it is a close end fund that trades at approximatly 14% nav. i would be interested to read what others think of this. you can also buy bullion stored in perth australia thru the euro-pacific fund-this should make it untouchable by our us government, gbest, md

2008 Dec 14 01:46 PM

[Briggsy:]

silas marner, I agree about the attractiveness of CEF. They have been around since the early 60s, and as stated in their shareholder reports make regular field trips to visit their gold and silver and take their auditors with them.

CEF is a closed-end fund however, not an ETF. So they are under no obligation to tender their holdings in the manner theoretically available to shareholders under an ETF share redemption procedure.

2008 Dec 14 02:07 PM

[Trace Mayer:]

ozzy43, 'Purchasing and storing physical metals are not.' is a misstatement of fact and I did provide examples of alternative vehicles which include purchasing and storing physical metals and 401(k) or IRA forms are acceptable.

However, GLD and SLV are a fairly convenient vehicle for 401(k) and IRAs as the alternatives require additional paperwork.

2008 Dec 14 02:08 PM

[Richard K:]

Ozzy43, it is possible to purchase physical silver and gold for an IRA. 1000 oz silver bars, for example, are stored in bank vault space rented by the IRA custodian. Each bar is listed by exact weight and serial number in the IRA owner's account, and the custodian cannot legally remove this metal for any purpose. Of course risk of physical theft (or assumed government confiscatory power) can never be eliminated for any object of value, but in this case at least the legal situation is unambiguous.

2008 Dec 14 02:26 PM

[Robert Nabloid:]

I've never fully trusted ETFs due to all the disclaimers. If you are one of those hardcore gold enthusiasts, it might be better to own the physical bullion yourself.

Yes, there are risks. The risk of confiscation exists, even with ETFs... perhaps especially with ETFs... The government has confiscated gold in the past and ETFs are an easy target of any future confiscation.

I'd rather have gold hidden where it can't be stolen or "confiscated" or re-taxed. As far as I'm concerned, the government already taxed my money. When I die, it will go to my heirs without being subject to death taxes.

I think this was an important article to be read by those that think gold or silver ETFs are completely safe and without risk. Thank you to the author!

2008 Dec 14 05:39 PM

[Steven Hansen:]

Any investment has risks. All assets have risk of loss. you cannot postulate every potential threat.

Please people, do not put your eggs in one basket. spread your assets around as much as possible.

This type of article is good, and while i can quibble here and there about what is being said - SA needs people like Trace to take the time to lay out arguments concerning each kind of investment.

2008 Dec 15 12:22 AM

[NOWHEREMAN:]

testing

2008 Dec 15 01:26 AM

[40 Act Atto...:]

Comments in the article about legal standards governing the liability of custodians are correct, but they are correct for virtually every custodial contract. In fact, they are the same standards as are used in a very large number of contracts in the financial services industry. They are merely a reflection of what lawyers on both sides (sometimes with the help of the SEC) deem is appropriate or required before entering into the contract. To point them out as risk factors here is only to highlight that the risks inherent in a golf ETF are pretty slight, with few risks worth highlighting. Open up a developing markets equity prospectus and you'll find a much meatier list of risks. One of the risks that probably will not be listed is the risk of storing equities with foreign custodians. This risk, which is greater than in the case of gold custodians, will not be listed because there are too many other risks in front of it.

2008 Dec 15 07:33 AM

[Livermore:]

CEF is half silver, half gold, and sells at sizable premium. Better for gold is GTU, also Canadian, which actually owns and stores the physical gold, and it is inspected from time to time by several parties including those who run the fund and the custodians. It too sells at a premium, but not nearly as steep -- yet-- as CEF.This should be a step better than GLD.

2008 Dec 15 10:00 AM

[Mark123:]

Why not own both.. physical gold you hold & GLD you trade.. I hold my physical gold as 1 strategy and buy GLD shares (100 at a time) and sell covered calls against it... 1 month out, at the money -makes me appx $300 to $400 per 100 shares owned...

2008 Dec 15 10:45 AM

[fran:]

agree. thanks for your warning advice and affirmation of author's article.


On Dec 15 12:22 AM The hand wrote:

> Any investment has risks. All assets have risk of loss. you cannot
> postulate every potential threat.
>
> Please people, do not put your eggs in one basket. spread your assets
> around as much as possible.
>
> This type of article is good, and while i can quibble here and there
> about what is being said - SA needs people like Trace to take the
> time to lay out arguments concerning each kind of investment.
>

2008 Dec 15 02:03 PM

[GMiki1:]

Yes, diversify even within your gold and silver holdings. I hold physical as well as GLD and SLV as well as stocks in these sectors. Everything comes with a risk attached. Everything.

2008 Dec 15 02:35 PM

[d_teller:]

RichardK:

Publication 590, explicitly FORBIDS the holding of physical commodities (and except for U.S. minted bullion) any bullion in an IRA. The Treasury has yet to rule on the "holdrs" and other types of combined asset securities that may actually receive physical commodities in their creation or liquidation accounts... but these may also disqualify an IRA. These prohibitions also apply to self-directed IRA's, with a possible exception if a trustee of a fiduciary institution gets a private-letter ruling from the IRS, that the set up and taxpayer (the IRA, itself) reporting information is properly set up.

I would read the first page of IRS Pub 590 very carefully, before purchasing any commodity-related ETF in a tax-sheltered account..

2008 Dec 15 05:16 PM

[Mark123:]

Thats not correct...It says..... "Your IRA can invest in one, one-half, one-quarter, or one-tenth ounce U.S. gold coins, or one-ounce silver coins minted by the Treasury Department. It can also invest in certain platinum coins and certain gold, silver, palladium, and platinum bullion." from page 49 - upper right.

2008 Dec 15 05:42 PM

[Master of t...:]

EFT's enable one to trade in and out of gold and silver without exorbitant premiums. You can also buy and sell quickly and in smaller increments than buying from bullion dealers. Anyone who has bought silver knows the storage problems associated with that. Those investors buying and selling physical metals get hit on the way in weith premiums and on the way out with discounts- hard to make a profit that way.

2008 Dec 15 07:25 PM

[secmaven:]

SLV holds its silver in London vaults. Confiscation by the US government is impossible. Gold is periodically withdrawn by redemption of shares in GLD and silver is withdrawn by redemption of shares in SLV. There has been not one report of a withdrawing party claiming that the gold or silver received was not the real thing.

2008 Dec 19 11:43 AM

[QuasiYoda:]

" There has been not one report of a withdrawing party claiming that the gold or silver received was not the real thing. " Yes secmaven and there won't be until it is to late. These ETF's have set the table for an easy transfer out of business . . . buy favors from the gov't, insure survival, etc

Bottom line We are moving deeper into a period where it is wise to distrust all large government, banking and corporate interests as they will ruthlessly act to insure their survival even if it costs you yours. The examples of this grow as each year goes by and likely will for another decade. Be very cautious and you will be rewarded for your caution. Expand your assets classes gold silver palladium, Swiss Francs diversify out of the dollar. A dollar devaluation will likely be seen in the next few years like Roosevelt's in the 30's Except this time no gold need be involved as the dollar is now pure fiat. Simply a Treasury announcement that each 10 dollars you hold is now worth 1 dollar. Presto Chango a 30 Trillion Dollar Debt is now only 3 Trillion. There would be a whole lot of complaining and large holders like China would squeeze the US for extra consideration but the most part "Fait Accompli" would be the phrase of the day (Translation: It is already done)

This is not some political swipe at Obama and crew merely stating
what will likely ensue after this years trillions thrown at the derivative madness in which we find ourselves. Gold and Silver are not Derivatives
These ETF's will prove they are at some point so use them advisedly and only after you have acquired a physical position in Gold and Silver.
Heavy on the Silver until we reach new highs then rebalance as we near the top of the next parabolic move


See Kondratieff Wave for perspective on where we are in the economic cycle remembering that the timing will need to be adjusted as we should have had our top in stocks back in 2000 but gov't tinkering to avoid the business cycle have merely extended it and the length/scope of the time of economic pain

2008 Dec 29 08:33 AM

[Pup:]

I, too, have read the prospectus / contract on SLV, which I hold. But it scares me. Of course, so do any of the other options with the physical, whether vaulted or not! I called the SLV people personally, and they said that only parties holding 500,000 shares could take physical delivery of the bullion. Just adding my two cents.

2008 Dec 29 08:24 PM

[johngonole:]

I haven't read teh prospectus but the language is not surprising. The days when people have any confidence in paper contracts is nearing an end. Think about insurance policies, bernie, SLV, your bank account if you have more than $100,000, on and on. Even health insurance. You have to be a doctor, a lawyer, and an actuary to really understand your risk. The legal speak behind the promises of financial services companies is just down right scary. We are selling you gold but hummm in the fine print in might not be THERE???? Amazing that its so easy to find a sociopath that didn't have a probelm writing that prospectus.

Being a structural engineer I think its high time I sub my work out to the indians. I'll hire myself a lawyer. That way I can put text in my general notes stating that the its possible that the third party's calculations are wrong or that I haven't done any calculations at all. That mistakes may have occured due to language barriers. Please be aware this design might not work. Damn I chose the wrong profession. I should have been a lawyer or a financial genius. The problem is that the damn lawyers have set everything up so no one is actually responsible for their actions unless someone dies or gets hurt. So everything is Ok unless blood is spilled. Our society is really really sick. Yet we all walk around pretending that the guy we voted for is OK and its the other party's fault. Still plenty of doctors and engineers in this country but for how long?

Mar 20 02:51 AM

[Griff777:]

Not true.

There is a lot more to this than the first page of IRS pub 590.

In 1997 Congress specifically approved the holding of gold and silver bullion in an IRA, the owner of the IRA just can't take physical possession of the metal, it has to be under the control of the IRA trustee.

As somebody else pointed out, page 49 of IRS pub 590 also allows certain gold coins to be held by an IRA trustee.

There are numerous side letters to individuals from IRS on holding the ETF GLD. Any professional broker will tell you that the IRS sees this as a fund, not as physically holding the gold bullion. Call the IRS and get a letter if it makes you feel better. There has never been even one IRA disqualified because the individual held the ETF GLD.


On 2008 Dec 15 05:16 PM d_teller wrote:

> RichardK:
>
> Publication 590, explicitly FORBIDS the holding of physical commodities
> (and except for U.S. minted bullion) any bullion in an IRA. The Treasury
> has yet to rule on the "holdrs" and other types of combined asset
> securities that may actually receive physical commodities in their
> creation or liquidation accounts... but these may also disqualify
> an IRA. These prohibitions also apply to self-directed IRA's, with
> a possible exception if a trustee of a fiduciary institution gets
> a private-letter ruling from the IRS, that the set up and taxpayer
> (the IRA, itself) reporting information is properly set up.
>
> I would read the first page of IRS Pub 590 very carefully, before
> purchasing any commodity-related ETF in a tax-sheltered account..

Oct 07 03:36 PM

[Griff777:]

And to follow up on holding the ETF "GLD" in an IRA (its ok), please see page 49 (of 94) of the prospectus for "GLD" - please note that the sponsor has a letter on file from the IRS that as long as physical delivery of gold is not taken holding shares of the ETF "GLD" WILL NOT RESULT IN A TAXABLE DISTRIBUTION.

www.spdrgoldshares.com...

"Investment by Certain Retirement Plans
Code section 408(m) provides that the acquisition of a ‘‘collectible’’ by an individual retirement
account, or IRA, or a participant-directed account maintained under any plan that is tax-qualified
under Code section 401(a) is treated as a taxable distribution from the account to the owner of the
IRA, or to the participant for whom the plan account is maintained, of an amount equal to the cost to
the account of acquiring the collectible. The Sponsor has received a private letter ruling from the IRS
to the effect that a purchase of Shares by an IRA, or by a participant-directed account under a Code
section 401(a) plan, will not be treated as resulting in a taxable distribution to the IRA owner or plan
participant under Code section 408(m). However, if any of the Shares so purchased are distributed
from the IRA or plan account to the IRA owner or plan participant, or if any gold received by such
IRA or plan account upon the redemption of any of the Shares purchased by it is distributed to the
IRA owner or plan participant, the Shares or gold so distributed will be subject to federal income tax
in the year of distribution, to the extent provided under the applicable provisions of Code section
408(d) or Code section 402. See also ‘‘ERISA and Related Considerations.’’

Nov 17 11:25 AM