“The rewards of gold stocks shall be distributed to a small number of investors; those who endure.”
—Stewart Thompson, www.321gold.com
After my presentation, I got more questions on the gold and silver ETFs, (GLD and SLV) than on any other area, so I thought I’d revisit my 2009 Seeking Alpha article on the subject and update it. I gave a presentation for the American Association of Individual Investors (AAII) on the West side of Los Angeles this past weekend. There were probably 150 “senior” investor types in attendance.
1. GLD is now operated by the SPDR people. The Risk Factor on page 6 of the updated 2011 gold ETF prospectus states, “This ETF is designed to mirror… the performance of the price of gold, less expenses.” As the GLD ad above shows, GLD is supposed to make things easy. http://www.spdrgoldshares.com/media/GLD/file/SPDRGoldTrustProspectus.pdf
The GLD ETF that promises easy gold ownership for America is only going to “mirror” the price. It doesn’t promise to do it, it’s only designed to do it. And if the mirroring doesn’t happen, well, it was just another errant Wall Street product.
The SLV prospectus, a BlackRock Asset Management iShares production, reads, “The purpose of the trust is to own silver transferred to the trust in exchange for shares issued by the trust.”(Summary of the trust, pg. vi.) http://us.ishares.com/product_info/fund/overview/SLV.htm. Note, that neither trust promises to actually fully own precious metals, or anything so prosaic.
Both trusts state that investors are not entitled to the protections of the Investment Company Act of 1940, or supervision by the CFTC, so as the preacher said to the Sheriff in Blazing Saddles, “You’re on your own, son.”
Any kind of a careful reading of these documents should tell you that these are highly precise pleadings written by $500 an hour lawyers, and are intended to be read by equally highly paid lawyers who might be thinking of suing the guys represented by the first group of lawyers. These masterfully crafted preamble sentences are nothing if not defensible.
2. GLD and SLV share price discounts: Perhaps the fact that the ETF prices are below the metal prices could have to do with the shorting of GLD and SLV shares by nefarious short seller types. With shorted shares, at the very least, you have two potential claims to ownership to an ETF share. With naked shorting, there could be lots of claimants. See www.shortsqueeze.com to see just how many of the ETF shares are short. There are 20 million shares short of GLD out of 399 million shares outstanding; and 22 million shares short of SLV’s 361 million.
3. Gold and silver acquisition: Many sources, including the World Gold Council, have noted that the quantity of gold mined the past four years has plateaued somewhere below 2500 tonnes a year. That averages out to about 48 tonnes of global gold production per week. Global silver mines produced 680 tonnes in 2010, or about 13 tonnes a week.
During the first two weeks of February, 2009, for instance, GLD said they acquired almost 103 tonnes of gold, more gold than was mined in the entire world during that two week period. GLD’s purchases left no gold for all those other gold bullion ETFs in the U.S., England, Switzerland, India or Australia. The claimed GLD purchases occurred smoothly and instantly despite gold buying attempts by London Metal Exchange buyers, the dental profession, gold fabricators, and even Central Banks. There isn’t that much scrap available to make up the totals.
As to silver, Eric Sprott said at a Doug Casey Conference last fall that he had one heck of a time acquiring bullion silver for his physical trust. How did the silver ETF do it? With derivatives. http://www.disclose.tv/action/viewvideo/67862/Eric_Sprott_Not_Enough_Silver__Theres_Nothing_Left/
4. Who has custody of the metal? The main GLD custodian is HSBC, the old Hong Kong and Shanghai Banking corporation (proudly built upon the opium trade long ago). There are also provisions for one or more “sub” custodians. And while the custodian is charged with a duty of due care in hiring the subs, there’s no assurance the subs won’t screw up.
The custodian for SLV is JP Morgans’ London office. JP Morgan is the firm currently being sued by dozens of law firms for manipulating the silver prices on the COMEX…from London. And SLV allows subs too.
The major sponsors, trustees, marketing agents, and custodians have created separate subsidiary corporations to provide even more limitation of liability for the parent. There were exemptions from legal liability for the GLD subsidiary players in the original S1 prospectus, filed on November 15, 2004, and for the silver custodians in the 2006 SLV prospectus. These have been improved upon.
5. Sub custodian shenanigans: Assuming GLD or SLV managed to find some metal and buy it, and some sub-custodian somewhere got possession of it, there’s nothing in the legal structure that prohibits the subs from leasing or even selling the gold and silver that’s been entrusted to them, and putting an IOU in the vault claiming they still own it.
The Bank of England is listed as a GLD sub custodian. We have a picture of the B of E’s gold room, but otherwise, nobody’s inspected it since the 17th century. Other sub custodians are the Bank of Nova Scotia (ScotiaMocatta), Deutsche Bank AG, and UBS AG. All are known to actively lease or otherwise trade in the London Bullion Gold Market, where paper is traded 100 times that of physical. For SLV, the custodian problems are equally slippery. (Pg 29 et seq.) I believe investors should assume that there will be trading and leasing of ETF assets,
6. “Regulation” of the ETF: After the FED’s failure to regulate much of anything, the SEC’s treatment of Bernie Madoff, the NYSE’s acceptance of High Frequency Trading that led to the ‘Flash Crash,’ and bank regulators’ encouragement of mortgage cheating at Countrywide, I barely see the point of mentioning regulation. There is NO adult supervision of banks or brokerages.
And as to auditors, the GLD prospectus clearly states that the auditor’s “responsibility is to express an opinion on the Trust’s internal control over financial reporting.” Somehow that doesn’t sound like anybody will count the bars or determine ownership.
7. If things do go wrong: If the Sponsor, Trustee, Custodian, Sub custodian, or Marketing Agent folks default, they’ll have high priced lawyers defending them everywhere. (Bankruptcy is not a totally unlikely scenario, considering the experiences of Bear Stearns, AIG, Lehman Brothers, CitiGroup, Fannie Mae, etc.) Since the prospectus excuses all sorts of GLD and SLV malfeasance, negligence, and probably even mistreatment of farm animals, customers would – at best – wind up as general creditors at a GLD or SLV bankruptcy. And investors will be far down the list of creditors behind bank lenders, bondholders, preferred shareholders, and common stockholders.
Oh, and there could be a few delays and costs involved…in the bankruptcy filing of a giant financial institution with claimants from all over the planet. Weren’t precious metals supposed to be without counterparty risk?
GLD and SLV are American ETFs, yet both metals are to be stored in London, and the custodians are both London based. It will be difficult to sue them in U.S. Courts. And it will be expensive to sue overseas. Weren’t there any suitable sub-custodians available in the U.S.? I hear Fort Knox is empty. Maybe they could store their metal there..
Also, there’s no requirement that the Trustee, Custodian or sub custodians carry insurance or a surety bond with respect to either gold or silver for the benefit of the trust. So even if a liability is found…there clearly won’t be any deep insurance pocket money.
8. But you can actually get real metal from these ETFs can’t you? Yes, Virginia, there is a provision in the prospectus for obtaining possession of the gold or silver bullion your shares represent. But it’s a hoax. You must own 100,000 shares of GLD and 50,000 shares of SLV to be able to claim your bullion. Hmmm, 100,000 times $145 a share for GLD would be $14.5 million dollars. For silver, that would be $43 times 50,000 or $2,150,000. Think the little guy is gonna write a check and ask for his metal? Think the mutual fund guy is going to tell his boss he wants to take delivery of 10,000 ounces of gold, or 1.6 tonnes of silver. “Gonna put that in the conference room, Tom?”
9. So why do these gold and silver ETFs even exist? My belief is that the real purpose of a bullion ETF is to have investors stay away from real precious metals and mining shares. And secondarily, to give the banks control of a pile of precious metals that they can continue to lease, short and trade at their absolute discretion.
If there is actually any gold or silver owned free and clear in the ETFs, down the road it will be easier for Uncle Sam to seize those assets than going after John Q Public’s coins. The pros like Soros and Paulson can use these ETFs to trade PMs, and get out quickly because they offer “liquidity.” But that’s all they offer.
10. There are other GLD and SLV critics. If you don’t agree with just my opinions here, there are other writers who don’t trust them either. Dave Kranzler, from whom much of this dissertation has been respectfully purloined, analyzed the GLD prospectus carefully in 2009, and found it seriously wanting. http://www.rapidtrends.com/2009/02/13/owning-gld-can-be-hazardous-to-your-wealth/
James Turk, long time precious metals market analyst, and the founder of London based www.goldMoney.com , has been critical of GLD since 2004. http://www.fgmr.com/fractional-reserve-aspects-of-gold-etfs.html
Jim Sinclair has chimed in with his opinion on these issues at www.jsmineset.com. He says that the only thing GLD owns is derivatives on gold, and that allows for much game playing to fool the rubes.
Attorney Trace Mayer has also written about these ETFs, saying they’re not a good idea. http://seekingalpha.com/article/110609-the-problem-with-gld-and-slv-etfs, by Trace Mayer in December 2008.
And what’s the matter with the closed end bullion funds, CEF, GTU, or PHYS? They really buy precious metal. I have reasonable assurance that they’re not leasing their metals. They have audits, insurance and trustworthy parents, and they entitle you to long term capital gains treatment. Sigh…not enough marketing on CNBC, I guess…
Finally, the University of Texas announced yesterday that they’d now bought $1 billion worth of physical gold for their $19 billion endowment fund. http://www.businessinsider.com/university-of-texas-gold-kyle-bass-2011-4
Hedgie David Einhorn, the guy who predicted Lehman’s collapse, sold his GLD earlier, and bought physical metal. Hmm, do these guys know something?
FF does not own either GLD or SLV. He does own CEF.