Why Choose a Physical Gold IRA Over Investing in a Gold ETF?
People often ask, “Why should I create a physical gold IRA? Wouldn’t it be a lot easier just to invest in gold ETFs using my existing IRA?“ Well, yes, it would be easier, but would it be wiser?
Before we get to that discussion, for those of you that may not be familiar with all the terms, ETF stands for “exchange traded fund.” ETFs are similar to mutual funds, but they have shares that are traded on the stock exchanges. For purposes of this article, the ETF under discussion is GLD, the largest and best known gold ETF.
In this article, we’re going to examine the “fine print” from the GLD Prospectus and reveal some startling facts about gold ETFs that most investors (maybe even you) don’t know. This information could change your thinking entirely about gold ETFs. Wall Street loves ETFs, but are they really good for you?
A Share Is Not a Share
Most investors seem to assume that when they buy “shares” in the ETF, GLD in this case, they become a shareholder just as if they bought shares of Ford Motor Company or some other business corporation.
To make matters worse, some investors even assume that by purchasing GLD shares they own a share of GLD’s gold. Be careful with making assumptions like that.
Even though they are referred to as “shares,” GLD shares are not “shares” in the same sense that most investors understand the term.
GLD is a trust, not a conventional business corporation. Legally, corporations and trusts are very different and play by different rules, both as to how they are treated for income tax purposes and as to how they are required to treat their “shareholders.”
Here’s what GLD itself says in its Prospectus (hey, somebody has to read those things, so I took one for the team:
The Shares do not represent a traditional investment and you should not view them as similar to “shares” of a corporation operating a business enterprise with management and a board of directors. As a Shareholder, you do not have the statutory rights normally associated with the ownership of shares of a corporation, . . . .
So, what you own are shares in a trust, subject to the terms of a trust agreement, not shares of a corporation in which you are entitled to vote the number of shares you own to elect a board of directors, or in which you have the protections afforded to stockholders of a corporation.
Where’s the Beef, Uh, Gold?
Let’s dig a little deeper into the Prospectus for GLD:
The amount of gold represented by the Shares will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold.
So, it looks like if you own “shares” of GLD the amount of gold backing up your shares is continuously reduced!
But hold on a minute. Isn’t the main reason investors buy GLD in the first place is to increase gold investments in their portfolios? Are you beginning to understand why so many precious metals advisers recommend physical gold in a segregated account over Gold ETFs like GLD?
Can ETF Shares Be Redeemed for Gold?
We’re not finished. Some investors in precious metals ETFs are operating under the mistaken belief that they, by owning shares in the ETF, have a claim on the ETF’s gold.
Wrong! When it comes to the average investor redeeming his or her shares, there is basically one option – cash, not gold, silver or any other precious metal.
Quoting again from the GLD Prospectus:
The Trust creates and redeems the Shares from time to time, but only in one or more Baskets (a Basket equals a block of 100,000 Shares).
GLD shares are selling for around $129 per share as of August, 2013. If my math is correct, that would mean you would need to have an investment of $12,900,000 to redeem a single Basket of GLD for physical gold.
Even then, there are other restrictions on redemption for physical gold, but you get the point. As a shareholder in a gold ETF, YOU DON’T OWN ANY GOLD! (Sorry for shouting)
What Happened to the Gold?
OK, so you’re thinking that about wraps it up. How could the outlook for a gold ETF investment get any worse? Back to the GLD Prospectus we go. As boring as a Prospectus can be, you have to admit that this is getting kind of interesting:
The Trust’s gold may be subject to loss, damage, theft or restriction on access.
There is a risk that some or all of the Trust’s gold bars held by the Custodian or any sub custodian on behalf of the Trust could be lost, damaged or stolen. Access to the Trust’s gold bars could also be restricted by natural events (such as an earthquake) or human actions (such as a terrorist attack). The Trust does not insure its gold. The Custodian maintains insurance with regard to its business on such terms and conditions as it considers appropriate which does not cover the full amount of gold held in custody. The Trust is not a beneficiary of any such insurance and does not have the ability to dictate the existence, nature or amount of coverage. Therefore, Shareholders cannot be assured that the Custodian will maintain adequate insurance or any insurance with respect to the gold held by the Custodian on behalf of the Trust.
In addition, the Custodian and the Trustee do not require any direct or indirect subcustodians to be insured or bonded with respect to their custodial activities or in respect of the gold held by them on behalf of the Trust. Consequently, a loss may be suffered with respect to the Trust’s gold which is not covered by insurance and for which no person is liable in damages.
Did I read that right? The Trustee does not insure GLD’s gold, and the Custodian and any sub custodians may or may not have insurance! What? How can that be? And, the companies handling, accounting for and storing the gold are not even bonded? As John McEnroe, the tennis star, used to say, “you cannot be serious!”
The Custodian is the firm engaged to store GLD’s gold. That Custodian can, in turn, engage sub custodians. So, the gold is farmed out to a company or companies who are not required to insure the gold and whose employees are not bonded. What’s wrong with this picture?
Need we continue?
Whose Gold Is It?
OK, I can’t resist. One last thing. Check this out, again from the GLD Prospectus:
Gold held in the Trust’s unallocated gold account and any Authorized Participant’s unallocated gold account will not be segregated from the Custodian’s assets. If the Custodian becomes insolvent, its assets may not be adequate to satisfy a claim by the Trust or any Authorized Participant.
In plain English, that means that the gold can be deposited into an unallocated account and mixed with the Custodian’s own gold, or even any Authorized Participant’s gold. So why is that a big deal?
It’s a big deal because that means the ETF’s gold can be mixed with the Custodian’s gold or with any Authorized Participant’s gold and thus become impossible to identify as the gold belonging to the ETF. If the Custodian or an Authorized Participant gets into financial trouble, doesn’t pay its taxes or files bankruptcy, the ETF is going to have to get in line with all the other creditors, and probably won’t recover a significant part of its gold.
In the beginning of this article the question was asked, “wouldn’t it be a lot easier to invest in a gold ETF?“ Technically, the answer is yes, but the caveat is that it would also be a lot easier for you to lose your investment. Remember that part about no insurance and no bonding, theft of the gold and terrorist attacks?
Make your own decisions, but at least now you are better informed about how precious metals ETFs really work. Even if the gold belonging to the ETF is not lost or stolen, by the ETF’s own Prospectus the amount of gold represented by the Shares will continue to be reduced during the life of the Trust.
And, when it comes time to cash out your shares, don’t even think about asking for physical gold unless you have an investment of over $12 million. Nope, when you cash out and assuming the shares still have any value, they are going to pay you in “Bernanke Bucks,” otherwise known as fiat currency.
The second question posed at the outset was, “would it be wiser to invest in a gold ETF?“ Having read this article, I’ll leave it to you to make your own assessment of wisdom.
Thanks for reading.