Misconceptions About Physical and Paper Gold

Editor's Note: This was originally posted on Minyanville's Buzz & Banter.


Minyan Jessica writes:
 

"What do you think of this article in the Financial Times a few days ago about Hinde Capital attacking the GLD ETF? Is there a trade here long physical/short 'paper gold'?"

Jess,

Unfortunately, I think Hinde Capital doesn't understand how physical gold is stored, or how GLD operates.

I’ve been debunking these GLD jabs for two years now. Allocated gold -- which is what the ETF owns -- is completely unencumbered, end of story. What the ETF’s spokesman said in the article is 100% correct. If you buy a gold bar from a dealer who has bought it from another dealer who has bought it from a bank that leased it from the ECB or Fed, do you think the ECB or Fed can then track you down and claim your bar as theirs? Of course not!

And the “gold equivalents” language in the ETF’s docs, which they are complaining about, only applies to ounces that are less than a bar because the trust holds only 400 oz. bars. It amounts to at most half a million bucks at any given time based on the present gold price, which in a trust worth $50 bln is totally immaterial.

With nearly 1,300 tonnes of fully allocated gold in it, the GLD ETF is probably the best thing that ever happened to gold from an investment demand perspective. How ironic is it that so many long-time conspiracy theorists that masquerade as gold bulls seem to be so intent on killing the golden goose? These people are apparently so used to being on the losing end that they can’t stand winning! (I also think a good number of these complaints about the ETF come from those with competing products, but that’s a whole other story).

Look, there are risks with the GLD ETF, just like any investment. For example, London (where the ETF stores its gold) could get nuked, the UK could go to war with the world and seize the gold in the ETF, etc. These are low probability events though. It’s probably more likely that somebody would come to your house and shoot you for your gold. Perspective is needed.

The GLD and other gold trusts (like Central Gold Trust (GTU)) that hold “allocated gold” are not “paper gold.” Similarly, gold miners are not “paper gold” either. The physical gold exists in the ground. Can a mine or allocated gold stored for a trust in a vault be expropriated? Sure it can. Again, there are risks with all investments. Even gold in your hand has risks. You can lose it. You could have it stolen, etc.

The real “paper” gold is the leased gold that central banks hold. These central banks that have leased their gold out will be the big losers if there ever is a true panic for physical that triggers a squeeze and leaves these leaseholders with empty hands except for the claim on “paper gold” at a bullion bank that may or may not have that gold anymore (or enough assets to be able to buy it back either).