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Tuesday, February 1, 2011

Gold and the GLD ETF

I don't normally discuss gold much on this blog, but I ran across an article recently, entitled "Who is Draining GLD?", that I think is worth mentioning as it raises some very important questions in my mind.  The article highlights some interesting data points about the ETF (Exchange Traded Fund) GLD that make you wonder, what was its original intended reason for being formed.  GLD is an ETF that is supposed to be backed by gold, as a matter a fact GLD is one of the larger holders of gold and tracks the price of gold.  This means that if the gold price goes down then GLD goes down as well.  This is not the only contributing factor as the NAV is calculated based on price of gold and the amount of gold held by the trust divided by the number of outstanding shares.  

Having said that, one more thing you should know is that its prospectus says that you can redeem shares of GLD for physical delivery of gold with one caveat, you must have at a minimum 100,000 shares to redeem.  Which means you have to have about $13 million dollars invested to create one basket for redemption.  This leaves a majority of the people out as they don't have $13 million to spend or at least not all in one place.  If you read the report by you'll see graphs that show the NAV price roughly running the same amount, while inventory of gold has been going down considerably in the last few months.  So very wealthy people have been taking physical delivery of gold from the trust, since July 2010 roughly 86 tonnes have been removed with the majority of that in the last 2 months.  

The advantages of having GLD shares is that theoretically you own gold or have exposure to gold without the storage costs that are incurred as the trust pays for that (or the individual share holders as a management cost). What are the advantages of taking physical delivery from GLD vs the futures exchange or buying from a bullion dealer.  Well if you buy gold on the futures exchange you move the price of gold making it more expensive (on-market), if you buy from a bullion dealer you have to pay fees/transaction cost per oz or something like that and getting it all may take more than one dealer for a large amount. 

After reviewing this information several questions popped into my head.  If the average Joe cannot take physical delivery and only the wealthy can, then who was this really set up for.  Also with storage fees and all being paid for by the trust is that just a way for wealthy to store gold and having average Joe pay for the storage costs as he has no way of actually taking physical delivery.  It is actually genius if this is really the case as a wealthy person I eliminate all the downside of owning gold and can take physical delivery of it when I want as much as I want (as long as it exists in the trust) without moving the price of gold or paying additional costs.  As a trading vehicle for average Joe it may make sense and a trader does not stay in very long and normally doesn't take physical delivery (and normally doesn't make a lot as that relies on market timing).  But for those who purchase it for long term safety (in an IRA or 401k or such) you have to wonder how protected they really are.  Now how protected they are really depends on if the trust could or would be drained of all of its gold (probability not very likely), but the question as to what the trusts true purpose still stands.  Was this just a side effect of how the trust was set up or was this created to protect those that can afford it?

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