10 reasons to avoid the GLD ETF

by Dave Kranzler

Given that the stated amount of gold in the GLD Trust has grown to over 850 tonnes, it appears that a lot of investors believe that investing in GLD is the same thing as buying physical gold bullion."

There may be many things to hope for in the oncoming Obama administration. Investing in the bullion ETF, GLD, is not one of them.

1. I'll start with the opening sentence of the gold ETF itself and work outwards to you. The opening sentence of the November 2004 gold ETF prospectus said, "This ETF is intended to track the performance of the price of gold." Note that it doesn't say it will own gold, or anything so prosaic. This Exchange Traded Fund that promises easy gold ownership for America is only going to track it. You know, like your cat tracking a crow in the back yard. And if GLD or your cat never quite gets there, well, it was an interesting exercise.

A careful reading of the first sentence should tell you that this is a document written by lawyers, and it is intended to be read by other lawyers who might be thinking of suing the guys represented by the first group of lawyers. The opening sentence is nothing if not defensible.

2. GLD Share Price: The current price of the ETF is said to be 1/10 of the price of gold. Yet, GLD's price is usually below the actual price of gold even as priced on the COMEX. Well, when GLD sells new shares that's the amount of money they get to buy gold. And they buy ounces of gold with it. This means that somehow, by some secret method, the guys managing a gold bullion ETF, while always behind the market, manage to pick up tonnes of gold at a discount to the COMEX price. This is not possible. The gold market is global and operates 24/7 all over the planet. If gold is under priced somewhere, it will be arbitraged like a Tonya Harding knee chop.

Think about it. Gold is currently very difficult to find under the earth. It's tough to mine profitably, much less mill and smelt, and insure, transport and store. Why would anybody be selling a bar of gold even near or below the price of an historically suspect pricing mechanism like the NY COMEX? Why is there no premium on these shares? The Central Fund of Canada (CEF) trades at a premium, but then, it goes to some lengths to actually buy and own gold bullion.

Only if there's some other "form" of gold being purchased, such as a derivative "promising" to deliver gold, can the pricing mismatch begin to be explained. (See #9 below, Jim Turk says there are only gold "deposits" involved here. And Jim Sinclair says gold derivatives are being used.)

Or perhaps the disparity of price could have to do with the shorting of GLD shares by those nefarious short sellers. With shorted shares, at the very least, you have two potential claims to ownership to a GLD share. If the shares were shorted naked, who knows how many claimants there could be. Want to go there?

3. Gold Acquisition: Then there's the amount of alleged gold acquired for GLD per se. Many sources, including the World Gold Council, the Sponsor of the ETF, have noted that the quantity of gold mined the past four years has plateaued somewhere below 2500 tonnes a year. Divide even that optimistic 2500 tonne number by 52 weeks a year, and you get about 48 tonnes of global gold production per week.

Yet, somehow, during the first two weeks of February, 2009, for instance, GLD said it acquired almost 103 tonnes of gold, more gold than was mined in the entire world during that two week period. (Don't ask about getting gold from above ground stocks. Do you think that owners of large piles of gold are selling these days?) GLD's purchases apparently left zilch gold for all those other gold bullion ETFs - the IAU in the U.S., and the British, Swiss, Indian and Australian gold ETFs in their respective countries.

These plentiful purchases of GLD occurred smoothly and instantly despite London Metal Exchange buyers, mining shortfalls, South African power failures, the dental profession, manufacturing, and even Central Bank buying. And GLD did all this buying without kicking up the price unduly?

India, which has been buying more than 25% of the gold coming out of the ground for years (said to be some 15 tonnes a week) apparently got none.

The OPEC countries, that have been buying a lot of gold through Istanbul, apparently didn't get any gold those weeks either.

And the jewelry industry, which supposedly absorbs over 70% of the gold mined each year, apparently surrendered its purchasing for the first two weeks in February so that ONE American bullion ETF could buy all the gold available.

Ever heard of a guy named Tino DeAngelis? Back in the 1960s, he said he had a lot of salad oil...and didn't. If you believed in Tino, and you believe in the GLD purchasing prowess, then you probably also believe in financial tooth fairies.

4. The Legal Structure of GLD. Who are these guys?

A. There is a Sponsor of the ETF - the World Gold Trust Services, a subsidiary of the World Gold Council in London.

B. There is a Trustee subsidiary that holds title to the bullion and issues shares - The Bank of New York (BK).

C. There is one listed Custodian - HSBC (HBC), and provision for one or dozens of "sub" custodians, Great, if something goes wrong, first you've got to find where which custodian allegedly had it. 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 afterwards and there's no real recourse if a sub does. Which brings up...

D. There is a marketing agent, for the shares - State Street Global Agents, a separate creation of State Street Bank (STT) in Boston, but they really don't answer anybody's questions. GLD is considered a "permanent offering" and the aforementioned marketing team can say nothing about anything during a permanent "quiet period." This ETF took two years to get through the SEC...And I'm not sure it didn't get the benefit of grade inflation on the SEC view of crookedness as it went along. "Hey," the SEC said, "This ETF isn't absolutely, totally rotten on its face, let it go through. At least it's not a CDO. Hah, hah."

Each of these outfits have created separate subsidiary corporations to provide more limitation of liability for the parent. There were marvelous waffle words, and exemptions from legal liability for even these subsidiary players in the original S1 prospectus, filed on November 15, 2004. These have been carried forward and even improved upon. See the prospectus.

5. Sub Custodian Shenanigans: Assuming GLD managed to find some gold and buy it, and some sub custodian somewhere got possession of it, there's nothing in the legal structure that prohibits the sub from leasing or even selling that gold and putting an IOU in the vault claiming it still owns it. Central Banks and the IMF have been shuffling these cards for decades.

The Bank of England is listed as a sub custodian. Other sub custodians are the Bank of Nova Scotia (BNS) (ScotiaMocatta), Deutsche Bank AG (DB), JPMorgan Chase Bank (JPM), and UBS AG (UBS) (Page 47). All are known to actively lease or otherwise trade in the gold markets. I.e., I believe that investors should assume that there will be trading or leasing of GLD assets,

When the gold bull market ran out of gas back the early 1980s a lot of allegedly respectable gold dealers who claimed to be storing gold for their customers, fessed up and said they didn't have it, and went broke.

On June 12, 2007, Morgan Stanley announced it had settled a case wherein a Mr. Silberblatt was charged for storage and insurance on silver that Morgan had never bought. And Morgan claimed in its defense that its "practices" were the "industry standard."

Such disreputable practices occur in most precious metals areas with great regularity. You really ought to consider deep therapy if you believe the promises of a financial institution these days if it's talking about gold. Hell, if it's stonewalled and fibbed to Congress, regulators, auditors and the media about almost everything, why wouldn't it lie about gold? (That's a rhetorical question.)

6. "Regulation" of the ETF: After the Fed's failure to regulate much of anything, the SEC's treatment of Bernie Madoff, and its elimination of leverage maximums for brokers, the NYSE killing of the NYSE Uptick Rule and circuit breakers, and bank regulators' encouragement of cheating at Countrywide, I barely see the point of mentioning regulation. There is NO adult supervision of financial guys. Customers are absolutely on their own.

Oh, ok, the Trustee can monitor the custodian "up to twice" a year (Page 37 of the prospectus). Oh, the ignominy of a visit from an official every six months. And there's no mention of what will happen if an inspecting official finds some wrongdoing. Probably just drop a note in a file. The Trustee apparently does not have the right to visit the premises of any sub custodian for the purposes of examining the actual gold, but only to visit to look at records maintained by the sub custodian. And no sub custodian is obligated to cooperate in any such review.

Finally, the prospectus clearly states that the auditor's “responsibility is to express an opinion on the Trust’s internal control over financial reporting.” Boy, that makes me feel better. Their processes are good.

7. If Things Do Go Wrong: If the Sponsor, Trustee, Custodian, Sub custodian, or Marketing Agent folks fall over, they'll have high priced lawyers defending them everywhere. (Bankruptcy is not a totally unlikely scenario, considering the recent performance of Bear Stearns, AIG, Lehman Brothers, CitiGroup, Fannie Mae, etc.) Well, since the prospectus excuses all sorts of GLD malfeasance, non-feasance, negligence, and probably even manslaughter, customers would - at best - wind up as general creditors of a GLD party. And investors will be far down the list of creditors behind bank lenders, bondholders, preferred shareholders, and common stockholders. Have you considered Lottery tickets for your retirement?

Oh, and there may be a few delays and costs involved...in the bankruptcy filing of a giant financial institution with claimants from all over the planet. And I doubt if specific performance is available to claimants in a bankruptcy proceeding to help people get the actual gold they thought they'd bought. Wasn't gold ownership supposed to be for safety without counter party risk?

And this is an American ETF, yet most of the custodians are British, European, or Canadian. Eh? It will be difficult to sue them in U.S. Courts, and it will be expensive to sue overseas. What, there weren't any suitable sub custodians available in the U.S.? I hear Fort Knox is mostly empty, maybe the ETF could store its alleged gold there.

Also, there is no requirement that the Trustee, Custodian or sub custodians carry insurance or even a surety bond with respect to gold. (Page 11). So even if a liability is found...there probably won't be any deep insurance pocket money.

In summary, the GLD prospectus is a steaming pile of legal loopholes. Only a lazy mutual fund manager or a brain-dead pension fund manager would touch this turkey. It's also likely that retail investors, and their highly compensated advisors, are even remotely aware of the astounding risks declared in the ignored GLD trust documents.

8. There are other GLD critics, besides the Financial Foghorn here, who think that the gold ETF is untrustworthy. Dave Kranzler, from whom much of this dissertation has been respectfully purloined, has obviously analyzed the prospectus carefully and found it wanting.

James Turk, a former money manager for the Saudi Arabian Central Bank, long time precious metals market analyst, and the founder of www.goldMoney.com, has been critical of GLD since it was proposed in 2004. And he recently noted that the August, 2008 GLD updated prospectus, on page 3, says: "Proceeds received by the Trust from the issuance and sale of Baskets consist of gold deposits and, possibly from time to time, cash." A "gold deposit" is a word that has a precise meaning in the law, and is the exact opposite of "bailment".

A bailment is what happens when you give your car to valet parking. When you present the ticket, you get your very own car back. With a "deposit," a bank gives you a certificate of deposit, a checking account statement, a savings book or some other evidence of its debt to you. You are no longer entitled to get your very own dollars back, but have become a depositor and general creditor of the bank. Title/ownership has transferred from you to the bank, and the bank can do whatever it wants with your former dollars.

It is extremely unlikely that a highly paid passel of lawyers that worked over the GLD prospectus would offhandedly put in a word like "deposit" unless there was a good avoidance-of-liability reason to do so. If physical gold were actually in the ETF, the above statement would have read: "Proceeds received by the Trust from the issuance and sale of share baskets consist of gold (or gold bailments) and, possibly from time to time, cash."

Turk's point, and Kranzler's reference, is that "gold" is one thing and a "gold deposit" is something entirely different. "Gold" is physical metal stored/bailed in a secure vault. A "gold deposit" is a liability of a financial institution, and it's just another lousy paper gold IOU. Whoops.

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.

9. But can you actually get real gold from GLD? Yes, Virginia, there is a provision in the prospectus for obtaining possession of the gold bullion your shares represent. Unfortunately, it's a cruel hoax. You must own a minimum of 100,000 shares (I believe it used to be 50,000 shares under the 2004 prospectus) to claim your bullion. Hmmm, 100,000 times $90 or so a share would be $9 million. Think the little guy is gonna put in for any actual gold? Think the mutual fund guy is gonna go to his boss and say he wants to take delivery of 10,000 ounces of gold? That's 833 pounds of gold. "Delivered here?" "Gonna put that in the conference room, Tom?"

10. So why do these gold and silver ETFs even exist?

My belief is that the real purpose of a bullion ETF is to be a sacrificial lamb. The growing number of gold and silver ETFs around the world will indeed accumulate some gold and silver, and under some Executive Order down the road, Da Boyz will swoop down and take it, just like 1933. They'll need the gold to back their spanking new, Global, Electronic, All-Beef currency. An ETF seizure will be much easier than going bank box to bank box to get citizens' gold.

Given the citizens' restiveness these days, it isn't hard to predict that it will be slightly more difficult in the 21st century to convince citizens to turn in gold than it was back in 1933. Our current politicos appear to have dissipated some of the trust people have traditionally had for their elected Representatives. (Insert your favorite, dastardly Congress-person examples here...)

And as far as legalities are concerned, the government will indeed comply with the 5th Amendment Taking-with-Due-Process issue by paying the investors for the value of gold on the day they seized it.

But that will be a far cry from the price of gold the day AFTER they seize it. The day after an ETF seizure, the world will realize that the paper jig is up, and everybody will want to own physical gold, or a real gold mining company. Why not do that now?