Is GLD a Good Deal?

By Julian Murdoch

GLD's largest shareholder, until recently, was noted hedge fund manager David Einhorn's Greenlight Capital hedge fund. Last week, we learned that he'd sold all of his GLD (SPDR Gold Shares (NSYE Arca)) holdings in favor of physical bullion. How much? About 4.2 million shares of GLD, or roughly $390 million.

So does Einhorn know something we don't know? Is the 40 basis points charged by GLD for the privilege of owning their shares a rip-off? Or a great deal?

Let's put some of the moving parts on the table.

The Challenge Of Owning Physical Gold

If you are going to buy physical gold, you first have to decide where you're going to store it. Sticking a few hundred thousand dollars of gold in a safe deposit vault is a bad idea, for one big reason: If you're buying large quantities of gold, the bars you buy will be serialized. They have provenance, and their acceptance as a thing worth a few hundred thousand dollars is based on an unbroken chain of ownership. Most bars never leave the big gold vaults; ownership simply moves from one buyer to another.

How much does this custody cost? Well, that varies, but on the cheaper end of the scale, you can go to someone like BullionVault.com, an online gold exchange that custodies just over 18 tonnes at the moment. BullionVault charges 12 basis points per year.

Once you decide where custody of your gold will be, you actually have to buy it, which means dealing with spreads and commissions in the variable precious metals market.

Spreads in particular can vary massively in the precious metals market. If you're a primary dealer on the OTC market, trading in 10,000 ounce blocks, your spread could be as low as 50 cents an ounce. For retail investors looking at pooled gold (where you are buying an allocated portion of a larger bar), a quick survey of available quotes suggests a spread of about 25 basis points is the norm.

Commissions are easy to figure out. If you're buying gold from a dealer, like Kitco.com, you won't pay a commission - Kitco's profit is built into the spread they charge. In the case of something like a pooled account, the spread varies, but a spot check last week saw gold offered at 936.20 on the bid and 941.20 on the ask, putting the spread at $5/ounce, or 50 basis points.

If instead you choose to do the buying and selling yourself on an exchange like BullionVault, your commission works out to be about 10 basis points for a million dollars of trading (more for smaller trades, less for larger).

So your round-trip cost for physical gold is the width of the spread, plus commissions in and out, plus a custody fee.

GLD

In comparison, buying GLD is easy. You enter the ticker into your brokerage account and, whammo presto, you own gold. You pay an expense ratio of 0.40% per year and the good folks at SSgA and (more specifically) their custodian (JPMorgan) take care of things for you, storing numbered gold bars in a vault in London.

There are a few additional expenses, of course. You have to pay a commission to buy and sell shares, which can range from $5 for an ultra-discount broker to as high as 4-5 cents a share for a full-service firm. And you have to pay the available spread, which Morningstar says averages about 11 cents per share.

For the sake of argument, I'm going to assume that over time, premium or discount to NAV isn't an issue, and indeed, the evidence is that the premium/discount is pretty normally distributed around zero.

The Scenario

With these ideas in place, let's walk through a thought experiment that quite a few investors might be considering right now.

Let's suppose I have $1 million, and I want to buy gold. What's the cheapest way?

My costs will be:

GLD: 40 bps expense ratio, 2 cents per share commission, 11 bps spread

Bullion: 12 bps custody, 10 bps commission, 25 bps spread

Now, three scenarios. First, I bought on July 1 a year ago, and I sold at the beginning of July this year.

GLD vs. Bullion: July 1, 2008 - July 1, 2009
Buy GLD			Buy Gold
Purchase at July 1, 2008
Price (Adjusted Close)	$ 92.66		Closing Price (London PM)	$ 937.50
GLD Investment (# Shares)	10,783		Ounces Purchased	1,064
Price Paid	$ 92.71		Price Paid	$ 938.67
Investment	$ 999,702.31		Investment	$ 998,746.88
Commissions	$ 215.66		Commissions	$ 998.75
Net Cash Outlay	$ 999,917.97		Net Cash Outlay	$ 999,745.62
(Spare Change)	$ 82.03		(Spare Change)	$ 254.38
Sale at July 1, 2009
Price (Adjusted Close)	$ 92.39		Closing Price (London PM)	$ 938.25
Book Value at July 1, 2009	$ 996,241.37		Book Value at July 1, 2009	$ 998,298.00
Price Received	$ 92.34		Price Received	$ 937.08
Sell for	$ 995,693.44		Sell for	$ 997,050.13
			Custody	$ 1,197.96
Commissions	$ 215.66		Commissions	$ 997.05
Net Receipts	$ 995,559.80		Net Receipts	$ 995,109.50
Closing Price Performance	-0.291%		Closing Price Performance	0.08%
Net Performance	-0.44%		Net Performance	-0.46%

The closing price performance is what you'll see if you punch the numbers into a charting program - it skips all the messy "how much does it cost" math. And as we see, that can be deceiving.

At the end of the day, while the reported price of gold was just barely positive over the period, your investment in GLD would have returned 2 basis points more than your investment in physical gold - a whopping 400 bucks on your million-dollar investment.

Of course, a minor tweak to any number of assumptions would swing this either way. Your commissions could be more or less on either side of the ledger. GLD often trades with spreads tighter than the 11 basis points implied here, and of course, if you're actively working your own trades on a gold exchange like BullionVault, your "spread" could be substantially better or worse.

But is either one a rip-off? Hardly, it seems.

Moving the period back another year does change the math though. Here's the same trade done 12 months earlier, for a two-year round-trip ending July 1 this year:

GLD vs. Bullion: July 1, 2007 - July 1, 2009
Buy GLD			Buy Gold
Closing Price Performance	42.09%		Closing Price Performance	43.30%
Net Performance	41.95%		Net Performance	42.37%

All of a sudden, things look less rosy for GLD. My actual realized performance on buying physical gold is ahead by 42 bps. Not super exciting, but still, 42 basis points on my million bucks is $4,200 I'd rather have than not.

And what about if we go three years out?

GLD vs. Bullion: July 1, 2006 - July 1, 2009
Buy GLD			Buy Gold
Closing Price Performance	48.59%		Closing Price Performance	50.61%
Net Performance	48.42%		Net Performance	49.44%

Now the choice seems pretty clear. My bullion performance is more than a percent higher than my GLD position.

Einhorn's Conundrum

The conclusion for us average investors is pretty clear: If you hold for a long time, bullion is likely a better bet. If you trade shorter term (or in smaller sizes), GLD is likely a better bet. And GLD is certainly the hands-down winner on convenience.

For Einhorn, a giant GLD position must have weighed on him like a lead albatross around his neck. His fund's $400 million position was costing him $1.5 million a year. That's a non-negotiable $1.5 million over which he had no control.

By contrast, a $400 million player in the bullion market has substantial room to negotiate. You can be sure his bullion holdings are being custodied for less than 12 basis points. You can be equally sure that he's able to navigate the waters of commissions and intermediaries far more skillfully than you and I can for our meager positions.

By making the move out of GLD, he gains instant negotiating power. He also avoids the public disclosure of GLD's 13F filing every quarter, disclosing his position whether he wants it disclosed or not.

And one interesting final note: What are the chances Einhorn sold his GLD on the open market? Zero. Far more likely, he negotiated with an authorized participant in GLD for a very large redemption. By doing so, Einhorn could theoretically have taken custody over physical gold already being held in the SPDR Gold Trust itself, with essentially zero costs. I'm not sure we'll ever know, but it's just possible that GLD served as a very convenient way to acquire an awful lot of physical gold.

Comments

[doubleguns:]

'The conclusion for us average investors is pretty clear: If you hold for a long time, bullion is likely a better bet. If you trade shorter term (or in smaller sizes), GLD is likely a better bet.'

I could not agree more. GLD is for trading, physical is for protection.

Jul 21 11:28 AM

[djj420:]

Didn't Einhorn redeem his GLD shares thru the trust? That's not the same thing as selling GLD.

Jul 21 11:46 AM

[E.D. Hart:]

And another point to consider: the fiduciaries of GLD are not compelled to audit the vaults or redeem for bullion.

You may not have access to physical metal when you really need it--a run for the valut window.

The prospectus for GLD reads like a manual on how to allow a ponzi scheme in the gold market. Caveat emptor.

Jul 21 11:56 AM

[DONE_SONZ:]

Most of us can't afford truck loads of gold,so why not own the physical?

Jul 21 12:20 PM

[Roger Knights:]

"Far more likely, he negotiated with an authorized participant in GLD for a very large redemption."

I believe the GLD prospectus states that they will deliver physical gold for redemption above some minimum amount. Probably Einhorn took advantage of that. (But most likely left the actual gold sitting where it was, merely acquiring ownership slips.)

Jul 21 02:26 PM

[US:]

You would be an idiot to own physical gold without taking into a/c insurance. Insurance has not been factored into the calculations above. Please do & rerun the calculations.

Jul 21 02:44 PM

[andypandy:]

he is not buying it because of the expensive expense ratio. he's buying it because GLD has no gold!

Jul 21 08:36 PM

[Bron Suchecki:]

What surprises me is that Einhorn bought GLD in the first place. With that sort of money, as the author points out, he has negotiating power. They only large investors who should be in GLD are those that are precluded from investing directly in physical gold by the rules of their trust or similar. That was one of the justifications the World Gold Council put forth for their sponsoring of GLD.

Jul 21 09:07 PM

[User 457933:]

I keep seeing articles that refer to the difficulty of holding physical gold. This does not make very much sense to me. Very substantial quantites of gold coins can be kept in a safe deposit box at a local bank. Does that make it inconvenient to trade? Of course, but at this point in the economic breakdown, why would anyone be thinking of trading his/her physical gold anyway? If one wishes to trade (not a great idea for most people), gold mining shares are a more suitable vehicle in any case.

Jul 21 11:12 PM

[TradingHelp...:]

Excellent article thank you. If you are buying gold for traditional diversification reasons, its low correlation to other asset classes, than an ETF or similar is fine, but if you are an "armegeddon" investor then you need real access to physical bullion don't you?

Jul 22 04:37 AM

[Ken P:]

My feeling is that Einhorn has read some of the same articles that many of us have. Articles that point out such things as:

- The GLD prospectus is a playbook for a ponzi scheme as a commenter above noted. It basically says they have no idea where the gold his, no way of auditing it, don't know or care if whatever they do have is actually real gold, and that if the company holding the gold goes bankrupt that they could lose the gold. If it were simply an issue of buying gold and selling an interest in it, as most people assume, bankruptcy of the custodian wouldn't be an issue except in terms of outright theft.

- The custodian of GLD, HSBC Bank, is also a huge short seller of gold. As custodian of GLD gold they have a huge pot of gold they can use to cover their short selling activities if necessary. Since the gold can't be audited, it is essentially theirs to do with as they please unless or until they go bankrupt or GLD changes custodian.

- If GLD gold is being used to support short selling activity, then buying GLD is actually helping to suppress the price of gold and hence an investment in GLD.

So if one is serious about owning gold then one buys physical gold and not paper gold like GLD.

Jul 22 06:28 AM

[zenharmonics:]

JIm Rodgers goes on Bloomberg last night and says their is no manipulation in the gold and silver markets. On the other hand, if it is true that HSBC, as a custodian of GLD, maintains huge short positions on the product they market to their own customers, then buying GLD, would, in fact, help drive down the price of gold. I have to question why Rodgers is saying what he's saying. Also consider the possibility JPM with a short position on its own product that represents 25% of all the silver mined in a year. This is a pretty strong accusation that I wish could be substanciated. If its not true, then my faith in Wall Street is restored. Some say this is why silver is now at a 70 to 1 ratio to gold when silver is at a 40 to 1 or lower ratio in the Earth's crust. Silver would be close to $25 right now if reality ruled. However, silver is used up in industrial methods unlike when the ratio historically has been 17 to 1 with little depletion. Accordingly, if silver traded at historical levels, the silver to gold ratio should be well below 17 to 1. All this leads me to put some credibility in the conspiracy theories even though Jim Rodgers seems to be more trusting.

On Jul 22 06:28 AM Ken P wrote:

> My feeling is that Einhorn has read some of the same articles that
> many of us have. Articles that point out such things as:
>
> - The GLD prospectus is a playbook for a ponzi scheme as a commenter
> above noted. It basically says they have no idea where the gold his,
> no way of auditing it, don't know or care if whatever they do have
> is actually real gold, and that if the company holding the gold goes
> bankrupt that they could lose the gold. If it were simply an issue
> of buying gold and selling an interest in it, as most people assume,
> bankruptcy of the custodian wouldn't be an issue except in terms
> of outright theft.
>
> - The custodian of GLD, HSBC Bank, is also a huge short seller of
> gold. As custodian of GLD gold they have a huge pot of gold they
> can use to cover their short selling activities if necessary. Since
> the gold can't be audited, it is essentially theirs to do with as
> they please unless or until they go bankrupt or GLD changes custodian.
>
>
> - If GLD gold is being used to support short selling activity, then
> buying GLD is actually helping to suppress the price of gold and
> hence an investment in GLD.
>
> So if one is serious about owning gold then one buys physical gold
> and not paper gold like GLD.

Jul 22 08:51 AM

[China Expert:]

Kitco marks up 1oz bars $25/oz, 10oz bars $15/oz, 100oz bars $8.50 oz and 400 oz bars $5.50/oz .... plus insurance and delivery. Where can I buy 1,000 oz for almost $1,000 in commission as in your model ?

Jul 22 09:50 AM

[petersterling:]

Only dumb, trusting pot smoking investors buy GLD as an investment. its for trading only. Everyone should have 10-30% of their assets in physical gold in their local bank safety deposit box right now.

The iron doors to financial safety are closing shut all over the world. The largest bubble of capitalism’s end-game is being shaped right now, a bubble of simply stupendous proportions, a bubble composed of extraordinary amounts of government debt; and, when this bubble bursts, governments and their (no-gold-holding) citizens will be its impoverished victims. don't be one of them.

The case for gold and silver is simple as it is old; as the same story has been repeated during the last 1,000 years, first in the East then in the West. Gold and silver were money. Then paper currencies backed by gold and silver were introduced by bankers and governments and were substituted for gold and silver. Then gold and silver were removed from paper money because governments had spent the gold while printing more and more paper money. As a result, every experiment with paper money ended in disaster. Hence the need for smart people to have some gold (and-or silver) under their own hand.

Giving your gold to GLD just helps the cartel in their shorting program to suppress the price. This cartel is good if you want to buy more physical gold at low prices.

Jul 22 12:25 PM

[tommy908:]

Maybe Einhorn was testing the system to see if his gold was there. Personally I think leaving that large amount of gold in the hands of one third party is like giving it all to one future Madoff.

Jul 22 06:35 PM

[jimmy46:]

You left a significant cost out of owning Bullion,
the cost of registered mail & insurance to & from BullionDirect or whomever.
Insurance is expensive & limited to $25,000.

Jul 29 04:12 PM