Sunday, February 7, 2010

Do You Own Gold?

The ownership of precious metals is an important, not-correlated to the stock market, alternate investment category. I say it is an alternate category because we do not see the category included in modern portfolio theory (MPT) allocations. We usually see it as a highly volatile and corrupt business sector and I have historically avoided exposure to it. During 2008 and 2009 I used SPDR Gold Bullion Trust (GLD) until I grew concerned about owners rights and other issues that I could not disprove. I miss it. In the current crisis conditions, gold and silver are taking on importance as a currency hedge and as a store of value. Some might use it as a hedge for inflation. Owning the metals is very desirable in a deflation economy, as a hedge against currency devaluation. Metals do not provide business risk and do not have common stockholders who demand certain behavior from management.

Currencies are being debased throughout the western world in the hope of saving banks, stimulating economic activity and restoring trade. Gold investment and central bank demand will likely remain strong because gold can function as a commodity, as a currency and also, unlike the US dollar, as a store of value immune from the hazards of currency devaluation caused by monetary inflation. As the only financial asset without counterparty risk, the historical reasons for holding gold, all but forgotten during the 1990s, have never been more clear. Metal is just metal. Pretty simple, right?

There are two ways to own the metals, in physical form where you take delivery, store and insure it, and otherwise take care of it, all at your expense. A more appealing alternative is to own the metals in paper form where you have ownership evidenced by shares in a trust that controls the metals. In paper ownership situations you must have other parties involved to perform the functions of physical ownership. There are the custodians, trustees, market makers and marketing parties, all who are paid for their services under an arrangement based on a percentage of the value of the metal.

Gold and silver are the most popular of the precious metals among retail investors and they can be easily owned in exchange traded form (ETF) under the names SPDR Gold Trust (GLD), iShares COMEX Gold Trust (IAU), and iShares Silver Trust (SLV). I am looking for a gold bullion investment. For this analysis I am going to try to set apart the differences between GLD and IAU. The information presented here will be exclusively taken from the prospectus and/or the FAQ's for each investment.

Purpose of investment in each...
"The objective of the trust is for the value of the iShares to reflect, at any given time, the price of gold owned by the trust at that time, less the trust's expenses and liabilities."

"The Shares are designed to mirror as closely as possible the performance of the price gold bullion, and the value of the Shares relates directly to the value of the gold held by the Trust, less the Trust's liabilities (including estimated accrued but unpaid expenses)."

Preference advantage - neither

Shareholder rights to gold bullion...

"The iShares are evidenced by certificates executed and delivered by the trustee on behalf of the trust. DTC has accepted the iShares for settlement through its book-entry settlement system. So long as the iShares are eligible for DTC settlement, there will be only one certificate evidencing shares that will be registered in the name of a nominee of DTC. Investors will be able to own iShares only in the form of book-entry security entitlements with DTC or direct or indirect participants in DTC. No investor will be entitled to receive a separate certificate evidencing iShares. Because iShares can only be held in the form of book-entries through DTC and its participants, investors must rely on DTC, a DTC participant and any other financial intermediary through which they hold iShares to receive the benefits and excercise the rights described in this section. Investors should consult with their broker or financial institution to find out about the procedures and requirements for securities held in DTC book-entry form."... "Individual certificates will not be issued for the iShares. Instead, a global certificate will be signed by the trustee on behalf of the trust, registered in the name of Cede & Co., as nominee for DTC, and deposited with the trustee on behalf of the DTC. The global certificate will represent all of the iShares outstanding at any time."... "Beneficial ownership of the iShares will be limited to DTC Participants, Indirect Participants and persons holding interests through DTC Participants and Indirect Participants."

"The Shares are neither interests in nor obligations of the Sponsor, the Trustee or the Marketing Agent. The Shares represent units of fractional undivided beneficial interest in and ownership of the Trust. A Shareholder does not have the statutory rights normally associated with the ownership of shares of a corporation. Each Share is transferable and is fully paid and non-assessable. The Shares do not entitle their holders to any conversion or pre-emptive rights. The Shares may only be redeemed by or through an Authorized Participant and only in Baskets"... "Authorized Participants may act for their own accounts or as agents for broker-dealers, custodians and other securities market participants that wish to create or redeem Baskets. An order for one or more Baskets may be placed by an Authorized Participant on behalf of multiple clients. As of the date of this prospectus, (3/2009), Bear, Stearns & Co. Inc., BMO Capital Markets Corp., CIBC World Markets Corp., Citigroup Global Markets Inc., Credit Suisse Securities (USA) LLC, Deutsche Bank Securities Inc., EWT, LLC, Goldman Sachs & Co., Goldman Sachs Execution & Clearing L.P., HSBC Securities (USA) Inc., J.P. Morgan Securities Inc., Lehman Brothers Inc., Merrill Lynch Professional Clearing Corp., Morgan Stanley & Co Incorporated, Newedge USA LLC, RBC Capital Markets Corporation, Scotia Capital (USA) Inc., UBS Securities LLC and Wedbush Morgan Securities Inc. have each signed a Participant Agreement with the Trust..."

Preference advantage - Question, who are Cede & Co and EWT, LLC ?
Cede & Co is named by DTC as a nominee. Answer, Cede & Co is a very suspicious role. They are technically the only owner of the global certificate which represents all of the iShares outstanding at any time and they have almost no public identity. Without much effort, I can conclude it does not want to be known. Try Googling the name yourself.  EWT, LLC is even less identifiable. They are named in the prospectus as an Authorized Participant as seen above. Their name is accompanied by household names which makes their name more conspicuous. Given the involvement of most of the other parties of the group in the credit crisis, if they were to say "trust me" in a currency crisis scenario, I would already be screwed. EWT has the same authority as all the other names and could be an entity that exists only to protect the interests of the others. Analysis is finished, early. GLD and IAU are too complicated to defend.

My conclusion from this analysis is that both GLD and IAU can do what they are hoped to do as a reflection of the value of gold, until they experience the kind of situation that investors are trying to protect against. And in the time of the greatest need, these two Trust's appear to have themselves well protected and their retail investors are not. My decision is to look for another way to hedge against a currency devaluation. Using currencies and exchange rate exposures are alternative's. Scanner