By Jared Cummans
The SPDR Gold Trust (GLD) is one of the most popular exchange traded products in the world, as it is home over $68 billion in assets and an average trading volume topping 16 million shares. This fund features a physically backed exposure to gold while charging fees of just 0.40%. The yellow commodity has been surging in popularity in recent years as the precious metal soared past $1,900/oz. while analysts and investors speculated about where the asset was headed. For many investors, GLD is their go-to investment vehicle for gold exposure and trading, as futures contracts can often be complex and dangerous [see also Why No Investor Should Own GLD].
Most investors feel comfortable with GLD's physical strategy, as holding physical bullion is the arguably the safest way to invest in the commodity, but does GLD truly hold physical gold bullion? In recent years there has been a significant amount of backlash from individual investors claiming GLD to be a sham and stating that the fund is nothing more than "paper gold". But calling out the second most popular ETF on the face of the earth is no easy task, as so many other investors have already ascribed to its strategy. The smoking gun of the ETF, many feel, lies in the prospectus and other filings from the issuer that many investors miss because, let's face it, not everyone read's the prospectus before investing [see also Why Warren Buffett Hates Gold].
The Smoking Gun
After digging through GLD's prospectus and 10-K filing, we picked out a few quotes and statements that many investors take issue with, but also statements that many may be completely unaware of. Below, we'll outline some of this controversial language as well as translating it from legal jargon in plain English, but rather than give you a definite answer as to how GLD behaves, we will present the facts to let you decide for yourself.
"Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss" - GLD Prospectus, Page 11.
Translation: The physical bars may not be up to standards of the London vault that they are actually held in and if it is discovered that the gold is in any way counterfeit or not pure, the fund and its respective shareholders, the Trust, can take a loss. This has led to a number of bloggers and investors accusing the fund of holding lead bars painted gold, or any number of other scenarios that involve fake gold in the vault. Note, this is standard legal language to simply warn of the possible risks and does not necessarily suggest that GLD holds fake gold [see also Three Reasons Why Gold Is Overvalued].
"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." - GLD Prospectus, Page 11.
Translation: Let's start with the custodian. According to Investopedia, a custodian is "a financial institution that has the legal responsibility for a customer's securities. This implies management as well as safekeeping". In short, the custodian is in charge of managing the gold bars to ensure that the vault holds the proper amount of the commodity. Moving back to the above quote, the issuer of the fund and the company who manages the gold does not always directly oversee the person who physically puts the gold in the vault, or subcustodian. Should the subcustodian lose a gold bar, steal, or damage any of the precious metal, the fund itself and the shareholders may bear the burden of the losses.
Again, this is standard legal wording to protect the issuer from any kind of lawsuit that would result from a rogue subcustodian. But let's be honest, the odds of a person successfully stealing gold from one of the most secure vaults in the world or damaging them are incredibly small. With a number of security measures in place and trusted employees, this is not something that many should worry about, but it is important to note that these risks, however small they may be, do in fact exist if you own GLD [see also 12 High-Yielding Commodities For 2012].
"The ability of the Trustee and the Custodian to take legal action against subcustodians may be limited, which increases the possibility that the Trust may suffer a loss if a subcustodian does not use due care in the safekeeping of the Trust's gold bars." - GLD Prospectus, Page 12.
Translation: Relating to the last quote, this one serves as more of a warning. If, by some miracle, a subcustodian was able to make off with a bunch of gold bars, or improperly cared for them, the shareholders and the fund may take a loss depending on the legal outcome. Legal action against said subcustodian may be limited, meaning that they are not sure if they will be able to win the case in a timely manner to restore the value back to the fund. Again, this is a safeguard built in to simply protect the company and to warn of all possible risks associated with investing in the fund [see also 50 Ways To Invest In Gold].
"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." - GLD 10-K Filing, Page 18.
Translation: Here is where a lot of people take major issue with the fund, and the above language is what has sparked a lot of controversy in the first place. Basically, it means that the issuer does not have the inalienable right to visit the vault at will to inspect the gold. In fact, the subcustodian, or the people involved with physically storing the bullion, can outright deny admission for inspection to the trustee. Justifying that last statement from a legal standpoint is a bit more difficult, but part of it likely comes from the fact that the vault can't have people showing up at will asking to see the gold. This may actually be a safeguard put in place to ensure that nobody views the gold under false pretenses and makes off some precious bullion, after all, this is one of the most secure vaults in the world [see also Gold Hits Resistance, Time To Worry?].
What To Do
By now, most readers are probably thinking, "Ok, so there is a risk that this fund does not perform in the manner that is supposed to" judging by some of the warnings in the prospectus. But for the most part, these are just legal necessities that exist with any fund. Take the SPDR S&P 500 (SPY) fund, which is also issued by State Street. With over $100 billion in total assets, SPY is not only the world's largest ETF, but also one of the largest funds period. It's prospectus also has a fair amount of warnings to investors. "There can be no assurance that the requirements of the Exchange necessary to maintain the listing of Trust Units will continue to be met or will remain unchanged" reads page 13 of SPY's prospectus. There is also a warning that the fund may not trade in line with its underlying securities, "the public trading market price per Unit may be different from the NAV of a Creation Unit on a per Unit basis" on page 12 [see also Kings Of Commodity Dividends: ETF Style].
The point is, you can find all kinds of legal wording that can make investment in even the most basic fund somewhat terrifying. Because GLD physically holds a large amount of one of the world's most precious assets, rather than stocks, it needs to protect itself from legal risks with such language. Still, the risks involved in the fund are real, no matter how miniscule they may be. The odds of GLD being a phony are practically zero, as a $68 billion dollar fraud would be one of the largest financial cover-ups in history. But for there are certainly two sides to every story, and investors seem divided on this issue. What do you think? Tell us in the comments below!
Disclosure: No positions at time of writing.