Is the GLD ETF Really Worth Its Metal? 29 comments
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In December I published A Problem With GLD and SLV ETFs where I briefly perused the GLD prospectus. It concluded, “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.”
QUALITY OF GOLD
From the original article, "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.' 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 (update: See comments 25 & 26)."
READER COMMENT RAISES AN ISSUE
A perceptive reader commented (#25):
But I’m not sure how you get to “an audit of the actual physical gold is precluded” from “the Trustee has only limited rights to visit the premises of the Custodian for the purpose of examining the Trust’s gold.” “Limited rights” is not “no rights”.
If Deloitte’s statement of 21 November in the 10-K is to be believed, they have “audited the … statements of condition … [and] such financial statements present fairly, in all material respects, the financial position of the Trust.” Now I am quite ready to be skeptical about the lengths DT went to check the gold was there. But, on the face of it, they have effectively stated that the $20bn worth of gold as per the balance sheet really exists and really belongs to GLD. And it’s hard to imagine they didn’t at least send someone to the premises of the Custodian to have a quick peep, though of course in this crazy world of mediocre financial services it is probably unwise to have 100% faith even in that. [emphasis added]
TRUST AUDIT RIGHTS OF THE CUSTODIAN OR SUBCUSTODIAN
The latest 10-K (Commission File Number 000-32356) on pages 26 and 18 respectively: ”Gold held by the Custodian’s currently selected subcustodians and by subcustodians of subcustodians may be held in vaults located in England or in other locations.” and “In addition, the Trustee has no right to visit the premises of any subcustodian for the purposes of examining the Trust’s gold or any records maintained by the subcustodian, and no subcustodian is obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian.”
The audit test was performed to the standard of ‘reasonable assurance’. Piecing these assertions together it could be possible for subcustodians to provide incorrect information, either negligently or willfully, to the Custodian concerning the physical gold quantity or quality. If the incorrect information came to the knowledge of the Custodian then they would issue Baskets. Regardless, the Trust is unable to visit the premises and examine the Trust’s gold or any records maintained by the subcustodians. As a result, the paper instrument would inaccurately represent the represented underlying physical bullion and the error would most likely not be discoverable.
INVESTMENT IN GOLD VERSUS GOLD
In the 10-K on page F-3, SPDR Gold Trust asserts an “Investment in Gold, at cost” of $16,878,554,000. The term ‘investment in gold’ is used in multiple places throughout the 10-K. This is contrasted with other terms such as ‘Proceeds from sales of gold’. This raises the issue of whether gold and investment in gold are synonymous terms?
In accordance with International Accounting Standard 1, The Bank for International Settlement’s Annual Report, under Accounting policies footnote 14, treats Gold as a financial instrument. Under Notes to the financial statements - part 5, the Bank is extremely careful to distinguish ‘total gold holdings’ as being comprised of ‘gold investment assets’ and ‘gold and gold deposit banking assets’.
In GLD’s case, the financial statements make a significant distinction between ‘investment in gold’ and ‘gold’. This is odd considering most companies do not make such a distinction between similar financial instruments such as ‘dollars’ and ‘investment in dollars’ or ‘euros’ and ‘investments in euros’.
Also odd is the lack of transparency over what GLD’s ‘investment in gold’ is comprised of. Is the phrase ‘investment in gold’ broader, narrower or completely different from the term ‘gold’? For example, can a COMEX futures contract, warehouse receipt or other similar OTC derivative fall under ‘investment in gold’? The term gold is well defined as a chemical element with the symbol Au and atomic number 79. Obviously, a warehouse receipt for gold is not gold unless the receipt is made of the chemical element of atomic number 79.
Mr. Turk addressed this particular issue and concluded, “If GLD declared its asset to be “Gold”, the fund’s auditor would have to substantiate that the gold really exists, which GLD of course cannot do because of the inability to audit or even inspect gold stored in subcustodians and sub-subcustodians, which is a risk noted in the prospectus.”
Because the Trust does have some gold in their vault, the auditors are most likely satisfied to a ‘reasonable assurance’ concerning the rest of the gold.
CONCLUSION
GLD ETF Trust supposedly holds more than 1,000 tons of gold. That amount is surpassed only by the United States, Germany, IMF, France, Italy and Switzerland; assuming they have the gold they claim. Under the GLD prospectus and latest 10-K, it appears that the Trust neither needs to own actual physical gold that constitutes atomic number 79 nor allow their auditors to see and touch the undefined ‘investment in gold’. I agree with the reader who asserted that ‘it’s hard to imagine they [auditors] didn’t at least send someone to the premises of the Custodian to have a quick peep’. In other words, ‘Just trust us, the gold is there.’ But why believe them?
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This article has 29 comments:
I say "paranoid enough", but flip the coin, and someone could call is "prudent enough".
This is the same due diligence and inquisitive streak that's missing in much of the investment community. This is what allowed Madoff, Stanford to occur.
In that spirit, I applaud the author for bringing up issues to be examined. With Wall street integrity the way it is, We need more inquisitive minds like these.
The due diligence does not matter until it is the only thing that matters.
On Feb 19 09:39 AM Consider_this wrote:
> In that spirit, I applaud the author for bringing up issues to be
> examined. With Wall street integrity the way it is, We need more
> inquisitive minds like these.
It is safe to say that, if things get really bad and markets close, GLD will be as useful as BAC.
Here's a question for any and all. Is what the author says about GLD also true of IAU? Does it have the same sort of "shady characters" he claims are behind GLD? According to Schwab the trustee is World Gold Trust Services, LLC, which sounds like it's a partnership with a corporate overcoat like a law firm. In Schwab's ETF comparison tool, GLD is shown as being in the Bank of New York Mellon Corporation fund family. Are the "shady characters" Bank of New York or the financial system in general?
IAU is shown as being in the Barclays Global Investors fund family, which makes sense since it is an "iShares".
For those that want to own gold because they truly believe there is big big trouble on the horizon, I recommand doing your homework on this fund.
GLD shares could very well collapse if oversight proves that the accounting is nothing more than a Madoff-inspired house of cards.
Good alternative 'hard-metal' investments are Kruggerands, Canadian Maple gold coins, American Eagle Gold coins which are held in your own safe or safe deposit box.
This statement reminded me of something...
Didn't that India firm, Satyam, have an famouse auditor, PwC, who for whatever reason didn't actually audit the actual bank deposits and merely trusted signed statements?
What was the amount of cash that was supposed to be there, but wasn't? I believe it was $1 billion in fraudulently claimed cash on its balance sheet.
If PwC didn't "at least send someone to the premise of the bank to have a quick peek" at Satyam's bank balance, how much faith can I put to this case about whether someone actually audited physical Gold in GLD.
Wow, the more I think about this, the scarier it is.
Unfortunately all of the variables and unknowns make a good analysis of risk/reward/overhead between GLD and physical gold nearly impossible to do.
My personal position on gold ownership is that it makes sense to spread your risks. I own part physical gold to avoid the risks of fraud, asset seizure, or counter-party failure. I also own part CEF to avoid the risks of theft and disaster.
If I was interested in trading gold, then owning it on an un-allocated basis (like GLD) or in futures would probably make sense.
Thanks a lot for your analysis Trace. The legal language chosen for GLD is very scary!
"The Custodian has no obligation to insure such Bullion against loss, theft or damage and the Issuer does not intend to insure against such risks. In addition, the Trustee is not responsible for ensuring that adequate insurance arrangements have been made, or for insuring the Bullion held in the Metal Accounts, and shall not be required to make any enquiry regarding such matters."
Now I work for the Perth Mint so these products are competitors, but is this not an incredible statement? The custodian does not have to insure it, we don't intend to insure it and the trustee is not responsible for ensuring it is insured. I don't have a problem with competition, but if you are going to market a product as gold backed, at least take responsibility for having and safely storing it.
The GLD prospectus is a steaming pile of legal loopholes. Only a lazy mutual fund manager or a brain-dead pension fund manager would touch this turkey.
It's also likely that retail investors, and their highly compensated advisors, are not even remotely aware of the astounding risks declared in the ignored GLD trust documents.
There are other GLD critics,
besides the Financial Foghorn here, who think that the gold ETF is untrustworthy.
Dave Kranzler, from whom much of this dissertation has been respectfully purloined, has obviously analyzed the prospectus carefully and found it wanting.
James Turk, a former money manager for the Saudi Arabian Central Bank, long time precious metals market analyst, and the founder of goldMoney.com, has been critical of GLD since it was proposed in 2004. And he recently noted that the August, 2008 GLD updated prospectus, on page 3, says: "Proceeds received by the Trust from the issuance and sale of Baskets consist of gold deposits and, possibly from time to time, cash."
A "gold deposit" is a word that has a precise meaning in the law, and is the exact opposite of "bailment".
A bailment is what happens when you give your car to valet parking. When you present the ticket, you get your very own car back.
With a "deposit," a bank gives you a certificate of deposit, a checking account statement, a savings book or some other evidence of its debt to you.
You are no longer entitled to get your very own dollars back, but have become a depositor and general creditor of the bank. Title/ownership has transferred from you to the bank, and the bank can do whatever it wants with your former dollars.
It is extremely unlikely that a highly paid passel of lawyers that worked over the GLD prospectus would offhandedly put in a word like "deposit" unless there was a good avoidance-of-liability reason to do so.
If physical gold were actually in the ETF, the above statement would have read: "Proceeds received by the Trust from the issuance and sale of share baskets consist of gold (or gold bailments) and, possibly from time to time, cash."
Turk's point, and Kranzler's reference, is that "gold" is one thing and a "gold deposit" is something entirely different. "Gold" is physical metal stored/bailed in a secure vault.
A "gold deposit" is a liability of a financial institution, and it's just another lousy paper gold IOU.
On Feb 20 10:52 AM The Mad Hedge Fund Trader wrote:
> GOLD! GOLD! GOLD! This is the cry being heard worldwide by investors
> in the Great Gold rush of 2009, looking for a generic “short America”
> trade. Where in the past gold seekers used sluices, shovels, and
> jackhammers to extract the glittery stuff in California’s Sierras,
> Alaska’s Klondike, and South Africa’s Rand, today the instrument
> of choice is the mouse. Online traders are unleashing clicks by the
> millions to buy ETF’s, American Eagles, mining shares, and futures
> contracts. With stock traders sitting on their haunches, wondering
> if the Dow will hold 7,000, this is the only thing that is working
> right now. Gold is no longer just catastrophe insurance. Traders
> are buying gold more for what it isn’t, than what it is. It isn’t
> made of paper, made in the US, or held in custody by Bernie Madoff
> or Stanford Financial. The yellow metal hit a new high for the year
> of $999 overnight, and the risk of a “melt up” is increasing. The
> Street Tracks Gold Trust ETF (seekingalpha.com/symbo...)
> is now the seventh largest holder of the barbaric relic in the world.
> For the newly aggressive, look at the DB Gold Double Long ETF (seekingalpha.com/symbo...),
> which gives you a 200% long exposure to gold, and is up 54% in a
> month. Who says there is nothing to buy out there?
So: if GLD has reserves that are larger than all but five countries (plus the IMF), then GLD must have many hundreds of millions of dollars in costs for security. When GLD adds a billion dollars worth of gold, there should be additional security costs.
For me to trust GLD, I want an audit of the total cost of the security. I don't want someone telling me, "It's secure enough, don't worry, our subcustodians are really smart guys..."
"Gold held for the Trust Allocated Account will be held by the Custodian in its own London vault premises except when the gold has been allocated in the vault of a subcustodian, and in such cases the Custodian has agreed that it will use commercially reasonable efforts promptly to transport the gold from the subcustodian’s vault to the Custodian’s London vault, at the Custodian’s cost and risk. Nevertheless, there will be periods of time when some portion of the Trust’s gold will be held by one or more subcustodians appointed by the Custodian or by a subcustodian of such subcustodian. Gold held by the Custodian’s currently selected subcustodians and by subcustodians of subcustodians may be held in vaults located in England or in other locations.
In other words, you can't assume there is a big issue with gold held by subcustodians unless you also assume that the Custodian has purposefully not used "commercially reasonable efforts promptly to transport the gold from the subcustodian’s vault to the Custodian’s London vault". Is there any evidence that prompt transport is not taking place?
As for "investment in gold" vs. "gold", that is simply semantics and there is no relevant distinction between the two. It is standard to use "investment in" as a balance sheet caption and actually preferable in this case. At the same time, you wouldn't say "proceeds from the sale of investment in gold". In any case, International Accounting Standards don't apply here at all, U.S. Generally Accepted Accounting Principles and SEC Rules and Regulations do.
The main problem with all the "audit doubters" is they totally discount the fact that the sole asset on the balance sheet of GLD is gold and there is virtually no risk that auditors would issue a report on the financial statements without performing adequate audit procedures which necessarily include a physical inventory. This is more than just a "peek" -- there are specific auditing standards that spell out precisely how to test gold in custodial possession.
Gina: The specific gravity of uranium is 19.05, for lead it is 11.35 but for gold it is 19.30. These differences are large enough that gold plated lead over DU can be easily detected using minimal procedures, not to mention that it would be exceedingly difficult to manufacture such bars. More likely if someone was going to do something like this they would use actual gold bars fabricated by refiners and subsequently drilled and filled by the fraudsters with about 40% tungsten (SG of 19.30, same as gold) but even that would involve a large chain of participants with a high risk of discovery.
Consider_this: The Satyam fraud apparently involved collusion by two PwC audit partners who were bought off. In any case, you don't test bank balances by sending people to the bank premises, you send a bank confirmation through the mail. You also look at bank statements and test some of the transactions by tracing them back to source documents. Could the auditors for GLD have been bribed like the Satyam auditors apparently were? Sure, but it's just as likely that the auditors for any other company have been bribed (which is not very likely at all for any particularly company, but clearly it does sometimes happen). The bottom line is that GLD is not unique in this respect, you could say the same thing about every company that gets audited.
Ironically, the risk of potential malfeasance is actually higher in an operation like Central Fund, Central Gold Trust, Bullion Vault, GoldMoney, etc. where the chain of authority is highly centralized and there aren't many overlapping checks and balances in place. Most of the recent frauds including Madoff, Satyam, Stanford, Adelphia, Worldcomm, etc. involved highly centralized operations with little segregation of duties or proper oversight at the executive level. These are all essentially very basic frauds with little collusion -- operationally very different from GLD and SLV where duties are decentralized between the Sponsor, Trustee, Custodian, subcustodian and Authorized Participant. If there is collusion between all of these parties it is a complex, extremely risky proposition that has no precedent.
In closing I'll note that London bullion vaults have not suffered an uninsured loss in several hundred years of operating history. Simply put, if you are worried about being cheated out of gold or silver, it is preferable to store it in a public warehouse run by many employees instead of a private facility run by one or two guys (or gals).
On Feb 19 10:02 AM Trace Mayer wrote:
> Consider_this, exactly. Given some of the unethical behavior of the
> players involved in the ETF which I discussed in the first article
> even more cause for prudence and caution may be required.
>
> The due diligence does not matter until it is the only thing that
> matters.