Is the GLD ETF Really Worth Its Metal?

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?

Comments

[Consider_this]

In other words, if you're paranoid enough, the wording in the prospectus does raise some creepy questions about whether GLD is really Gold. In fact, I would carry it one step further that if it's so hard to confirm the Gold while the Fund is still running, imagine at some point, the fund needed to dissolve orderly -- is that even possible with all the questions brought up by the author is a valid concern.

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.

2009 Feb 19 09:39 AM

[Trace Mayer]

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.


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.

2009 Feb 19 10:02 AM

[mr freddo]

As a GLD holder, I thank you for the article. The fact is, that in this financial environment, paranoid is prudent. I would hate to be right about gold as an investment, but be wrong about GLD.

It is safe to say that, if things get really bad and markets close, GLD will be as useful as BAC.

2009 Feb 19 10:08 AM

[Grass Ranger]

I dare say that a lot of current holders of GLD don't really care if the "gold" is there. They are using GLD in a trading strategy. It is easy to buy and they expect to sell out at some higher price. After reading other commentary similar to the above, I have sold out my GLD holding and used the proceeds to buy Eagles. I am looking for portfolio insurance, not some speculative instrument in this current turmoil.

2009 Feb 19 10:22 AM

[fatcat]

More arguments for physical gold...

2009 Feb 19 10:22 AM

[Reggie]

I wonder if the author could/would comment on IAU--the i shares COMEX Gold Trust? Do the same issues exist here?

2009 Feb 19 10:47 AM

[Anandakos]

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".

2009 Feb 19 10:48 AM

[sdavid0419]

It became obvious as the SEC was questioned by Congress that they were a bunch of inept past employees of the companies they are charged to oversee. If the author of this article can get this information an oversight board should also be able to. Perhaps its time for investors to create their own oversight board and give or withhold its seal of approval (akin to the goodhousekeeping seal of approval). I never thought that I would see the day in my lifetime where I completely have lost faith in the SEC, Moodies, and all the other just trust me types. I heard the other day that $85 billion dollars have been withdrawn from banks and placed in mattresses and coffee cans. Perhaps our new President has it all wrong. It isn't necessary to immediately spend 100billion dollars that you don't have. It is immediately necessary to find a way to restore confidence in the investment system instead of sending more bad money after good. When my pipes leak I have to turn off the water and fix the problem before I can put any more water in the pipes.

2009 Feb 19 10:51 AM

[GMiki1]

The CFTC needs to do something about the illegal manipulation of the COMEX as well--or, especially. Why are a couple of big banks allowed to naked short silver and gold? How do I know it's naked? Ted Butler tells me so. But, hey, shorting 25 percent of silver production means you have an awful lot of silver...

2009 Feb 19 11:14 AM

[Bondtrader]

For those of interested in other funds that hold physical gold I recommend you check out gold-trust.com. Central Goldtrust trades on the AMEX GTU and usually trades at a significant premium to its NAV.

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.

2009 Feb 19 11:36 AM

[MonicaLewinsky]

The author's points are exactly why I sold my position in GLD recently. While GLD provides trading liquidity for people who want to hold gold, that liquidity is worthless if GLD shares collapse.

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.

2009 Feb 19 11:47 AM

[KSAccountant]

As an accountant and someone interested in GLD over the years, I appreciated your indepth analysis of the 10-K and other statements. As an auditor, the whole situation sounds very much like another ENRON is going on. Thanks for helping me make my decision on GLD.

2009 Feb 19 11:56 AM

[Consider_this]

"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."

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.

2009 Feb 19 12:56 PM

[wengem]

Don't forget that there is risk and overhead in owning physical gold too. You have to consider the possibility of theft and counterfeiting. It's much less liquid than GLD. You are also likely to pay a significant premium to the spot price and have a hard time recouping all of that premium when you sell.
Unfortunately all of the variables and unknowns make a good analysis of risk/reward/overhead between GLD and physical gold nearly impossible to do.

2009 Feb 19 01:45 PM

[wengem]

Correct me if I'm wrong, but doesn't GLD trade at a discount to their holdings - expenses? If that's true, some portion of the counterparty risk is mitigated.

2009 Feb 19 02:06 PM

[ff4444]

Info on IAU would be interesting, but it probably doesn't matter too much since CEF exists as an alternative. From the prospectus, the CEF trust can actually visit our gold in Canada ;-) In fact they are required to visit it with their auditors twice a year.

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!

2009 Feb 19 02:27 PM

[agneaux]

So what you're saying is, we're playing musical chairs with GLD and SLV and hoping the music doesn't stop until after we've cashed out? Ohhh...my head hurts already.

2009 Feb 19 02:33 PM

[Bron Suchecki]

Consider this from the prospectus of the Australian ETF securities product GOLD clause 3.2:

"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.

2009 Feb 19 06:02 PM

[E.D. Hart]

Yikes!!!!!!!!!!!! After the current meltdown, why trust any financial statements without triple checking? I own Physical gold for precisely this reason.

2009 Feb 19 07:22 PM

[KBowen7736]

The mere fact that these "GLD storage issues" have been floating around unanswered for a few years now, having been raised by some of the most influential hard money brokers, speaks volumes. The silence by an ongoing business concerning the ethics and the potential ruination of their business model is deafening. The answer to everybody's concern is as obvious as the nose on your face. Be warned!

2009 Feb 20 08:45 AM