There is much speculation and misunderstanding about the largest gold ETF, the SPDR Gold Trust (GLD). GLD is an exchange-traded fund (ETF) that purports to be backed by physical gold and to track the spot price of gold on approximately a 1/10th basis, minus fees and expenses. (This means that if the spot price of gold is $1700, 1 share of GLD should be very close to $170.)

If you are considering adding GLD to your portfolio, I recommend you do a little studying first and know what you are getting into…it’s not necessarily a bad option, but there are 8 potential “gotchas” to beware of:

1. Does the share price accurately track the real spot price of physical gold, and will it be able to do so in a mania?

Currently the answer to this is “maybe”…

When GLD first came out, in late 2004, it did track the gold price quite well. However, over the years, the discrepancy between the share price of GLD and the spot price of gold has slowly increased. Let me show you:

As I write this, the spot price of gold is $1717 (it has just dropped significantly in the past hour along with the plunge in ES). And a share of GLD is $167, which would reflect a spot price of $1670, a difference of $47, or 2.7%.

If we take a look back, a few months ago, we can see what happened on a day when the spot price of gold soared:

Back on August 22nd of this year, gold rocketed past $1800/oz., briefly passed $1900, and closed (NY Spot Gold) at $1898.10. That same day, a share of GLD closed at $184.59, reflecting a spot price of $1846 for a $52 difference, or 2.7%.

So, no big deal so far, right? If the discrepancy between the GLD share price and the gold spot price is constant (meaning it’s 2.7% lower when you buy but also 2.7% lower when you sell) this might not be so terrible. However, let’s look back a few years…

8/22/2005: $437.80 NY Closing spot price
8/22/2005: $43.70 GLD price

This is much less than 2.7%…back in 2005, the share price of GLD trailed the spot price by only .18%! So depending on your time horizon, and if the discrepancy continues to increase, it could spell some missed profits for your portfolio.

And if you look closely, you’ll see that this is actually built into the GLD prospectus itself (which, if you are a glutton for punishment, you can read here…),

“The sale of gold by the Trust to pay expenses will reduce the amount of gold represented by each Share on an ongoing basis irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold…Assuming a constant gold price, the trading price of the Shares is expected to continue to gradually decline relative to the price of gold as the amount of gold represented by the Shares gradually declines.


2. You cannot exchange your shares of paper gold for actual physical gold.

GLD is not and never has been intended to be redeemable for actual physical gold. It was designed simply to track the price of gold and allow more investors easy exposure to the price of gold without the option of taking delivery. It is currently redeemable only to “Authorized Participants” in blocks of 100,000 shares, and the list of Authorized Participants is a select group of 16 of the largest global banks such as Goldman Sachs, JP Morgan, UBS, HSBC, etc.

So, unless you have $171,700,000…you cannot redeem any of your GLD shares for gold.

3. Potential for fraud– does the physical gold truly exist behind the paper?

Here is where many “conspiracy theories” come into play. Multiple audits have been performed on GLD in the past, but unfortunately, these audits have raised more questions than they have answered and have shown some discrepancies in the number, weight, and serial numbers of the bars of gold.

Most recently, CNBC’s Bob Pisani visited GLD’s vault and filmed a segment on the gold. Hilariously, though, this only spawned more conspiracy theories, because the bar of gold that was zoomed in on while he spoke on camera was “ZJ6752”, which was nowhere to be found on the full bar list that is posted daily by GLD. Here’s a great pic, and you can read the funny story about it here on ZeroHedge:

Gold Bar? Or Tungsten....

Gold Bar? Or Tungsten... ***Photo courtesy of Zero Hedge

Additionally, the GLD prospectus itself states,

“The Trust may not have adequate sources of recovery if its gold is lost, damaged, stolen or destroyed and recovery may be limited, even in the event of fraud, to the market value of the gold at the time the fraud is discovered.”

Buyer beware.

4. Conflict of Interest

Two of the custodians for GLD are JP Morgan and HSBC, companies that are also players in the wholesale gold market and who have been accused of manipulating the gold market and suppressing the price of gold (note: these allegations have yet to be confirmed by the CFTC, but there is a big enough movement behind the allegations that it has formed its own organization called GATA, the Gold Anti-Trust Action committee).

5. Fund expenses

From page 1 of the GLD prospectus,

“The investment objective of the Trust is for the Shares to reflect the performance of the price of gold bullion, less the Trust’s expenses.”

Yes, ETFs tend to have low expense ratios, but you will still be losing some money to expenses (and whatever trading fees your brokerage charges).

6. Not regulated by the CFTC (Commodity Futures Trading Commission)

Also from the very first page of the GLD prospectus, we find,

“The Trust is not a commodity pool for purposes of the Commodity Exchange Act of 1936, as amended, and its sponsor is not subject to regulation by the Commodity Futures Trading Commission”.

7. Bars in trust not guaranteed to meet London Good Delivery Standards

“Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss.” GLD Prospectus, page 11.

Basically, the Trust “requires” that its bars meet “London Good Delivery Standards”, but they never actually verify that the bars actually do meet these standards (hence all of the articles and conspiracy theories alleging that the bars are actually gold-plated tungsten).

8. Taxation

Finally, because GLD is an ETF, you may think that it is taxed like most securities, where if you hold it for longer than one year you will pay the long-term capital gains tax rate, currently 15%.

However, GLD is not structured as a mutual fund…it is set up as a “grantor trust” and is therefore taxed at the underlying commodity tax rate. Gold is considered a “collectible” by the IRS, and is taxed at the long-term tax rate for collectibles, which is currently 28%, NOT 15%. And, if you sell it in less than one year, it is taxed at your ordinary income tax rate. Ouch.

In sum, the GLD ETF has several gotchas that investors should be wary of! Yes, it is highly liquid, easy to trade, and saves you many hassles of physical gold ownership, but it is not without risk.

So there you have it: do your homework before you jump into GLD!

I personally prefer physical bullion for all of the reasons listed above (but that has its own set of “gotchas” to beware of and is the subject for another day!).

To your financial success,

— Kung Fu Girl