1. What does the trust actually invest in?
The SPDR Gold Trust has made assertions through its prospectus and marketing materials that it holds only physical gold. This appears to be true. Back in August when gold was racing towards $1900 per ounce, the Trust went to great lengths to assure the world that GLD actually had physical gold within the trustee’s designated vault walls. CNBC’s Bob Pisani was invited to London and was allowed a peek inside the Trustees’ vault which is owned by HSBC. However, Pisani claimed he could not disclose the physical location of the vault and that he was driven blindfolded to get there. The gold vault is one eye-opening view of the fund but so is the fund’s prospectus, so let’s take a look. There are several pieces of information in the prospectus of the SPDR Gold Trust that investors should aware of.
In the SPDR Gold Trust’s Prospectus (.pdf) we find the following statement:
The Shares do not entitle their holders to any conversion or pre-emptive rights. The Shares may only be redeemed by or through an Authorized Participant and only in Baskets.
In layman’s terms, this means that the individual investor who owns shares in the trust may not have his shares converted to gold. And in the next paragraph from the prospectus we learn that authorized participants may resell the gold in the baskets to other investors. This is where things get a bit murky for the average investor and analyst attempting to make sense out of the fund.
Baskets may be created or redeemed only by Authorized Participants, who pay a transaction fee for each order to create or redeem Baskets and may sell the Shares included in the Baskets they create to other investors.
2. What is the role of an Authorized Participant?
According the prospectus an authorized participant is as follows:
Baskets may be created or redeemed only by Authorized Participants. Each Authorized Participant must (1) be a registered broker-dealer or other securities market participant such as a bank or other financial institution which is not required to register as a broker-dealer to engage in securities transactions.
According to thismater.com in an article on ETFs:
Retail investors have no relationship with the ETF sponsor. Only Authorized Participants offer ETF shares for sale on the stock exchanges. A holder of ETF shares does not own a portion of the securities held by the ETF sponsor, but owns a portion of the creation unit held by the Authorized Participants.
Theoretically, the authorized participants could do all sorts of magic with their baskets that the Trust itself cannot do, including leasing, and lending, or using them for collateral on other investments. I find no restrictions to this regard in the Trust’s prospectus.
There is really no way for the individual to know how many individual investors own shares versus institutions, and for what purpose they are owned, swapped, or traded.
Something even more disconcerting is a statement that informs the investor that the authorized participants have basically two business days from the creation date of their baskets to ensure gold is in the vault to cover the issue price of the basket. Can you imagine what this could do to the price of gold in a short squeeze, or if some unknown event sends gold higher? This could be disastrous for the authorized participant who in all likelihood is a major bank or stock brokerage firm if they are unable to deliver.
An Authorized Participant who places a purchase order is responsible for crediting its Authorized Participant Unallocated Account with the required gold deposit amount by the end of the second business day in London following the purchase order date.
3. Can the Fund be dissolved or terminated?
According to the prospectus there are terminating events, or events which could trigger the dissolution of the fund. One such event raises further questions as to exactly what it is that GLD actually is up to:
The Sponsor may also direct the Trustee to terminate the Trust if the Commodity Futures Trading Commission, or the CFTC, determines that the Trust is a commodity pool under the Commodity Exchange Act of 1936, as amended, or the CEA.
What is a commodity pool? According to the online financial dictionary Investopedia, a commodity pool is “A fund that collects investor contributions for use in futures and commodity option trading." Other terminating events are related to the size and the value of the fund such as should it get too small to allow it to be listed on the stock exchange.
4. Is the fund a tax trap for investors?
According to an article from the Wall Street Journal, GLD is treated like a collectible investment when it comes tax time:
Or consider SPDR Gold Shares. The fund holds nearly 37 million ounces of gold, so the IRS taxes your capital gains at the 28% rate for collectibles—even if you have held your shares for more than one year. "We try really hard" to make sure investors are aware of that higher tax rate, says James Ross of the fund's sponsor, State Street Global Advisors.
This makes a good case for buying such a fund only in an IRA, unless you are willing to fork over nearly a third of your gains to the tax man.
5. Is the stored gold safe?
One would think that yes, the gold is safe, yet a good deal of the prospectus addresses the limited liability of the Trust should the gold be stolen, or it be discovered that some of the gold is counterfeited or not up to the fineness requirements. The individual investor has absolutely no recourse in such matters. According to the prospectus and set in bold font:
Because neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians who may temporarily hold the Trust’s gold bars until transported to the Custodian’s London vault, failure by the subcustodians to exercise due care in the safekeeping of the Trust’s gold bars could result in a loss to the Trust.
But one would suppose such caveats are necessary and required in the risk sections of any given investment prospectus.
So as with any investment, buyers of the GLD should take full measure of the phrase: Buyer Beware.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
