September 5, 2011
There are many ways to take advantage of the current bull market in the precious metals – gold & silver. It can get a little confusing, especially to the investor just beginning to look into the matter.
The easiest, though not necessarily the safest, way to take part in the precious metals market is to utilize the stock market and invest in an ETF (Exchange Traded Fund). An ETF is essentially a derivative because it derives its stock value based on the price of the underlying precious metal. For example, the biggest gold ETF is the SPDR GLD Trust (Ticker=GLD). The GLD ETF claims to hold a certain allocated amount of gold in a vault somewhere in London. It is this physical gold that would give value to each share of the GLD stock.
However, it would be preferable if the ETF in question would allow the stockholder to receive his/her gold upon request. According the the GLD prospectus if a certain stockholder has a Basket of 100,000 shares, they may act through an Authorized Participant to redeem their shares for physical gold. But most people aren’t wealthy enough to own that many GLD shares.
So what would happen if some unforeseen economic crisis caused such a stir that all those stockholders who are wealthy enough to have that many shares decided to redeem their Baskets? There is a very good chance that the value of the stock itself would crash because there isn’t enough gold supporting the outstanding shares – some shareholders would be left with shares that don’t have any supporting underlying metal. To see the reasons why this could happen, one only needs to investigate two things:
- First, look at the NAV (Net Asset Value) of a basket of GLD shares in terms of ounces of gold. From the perspectus:
“The number of ounces of gold required to create a Basket or to be delivered upon the redemption of a Basket gradually decreases over time, due to the accrual of the Trust’s expenses and the sale of the Trust’s gold to pay the Trust’s expenses.”
This means that as time goes by, even those wealthy enough to own 100,000 shares of GLD, will get less and less physical gold when they redeem them.
- Second, there is a huge amount of short interest in the GLD stock as can be seen here. At the time of this writing, the short interest is about 6%. And that represented 24,570,100 shares which had absolutely no metal backing up those shares. If this were a temporary occurance, one may forgive the situation as it would be necessary during the periodic volativity of trading activity to temporarily issue shares while the Trust’s sponsor accumulated the metal in the open physical market. But since this short situation is rather constantly above this percentage, it is not a temporary thing – indeed it is an aberration! There shouldn’t be naked short shares exceeding the neighborhood of 1% of the outstanding share base (and that’s even extreme for this kind of investment vehicle which attempts to map a certain amount of physical metal to each share).
The same situation results in an investigation of the largest silver ETF, iShares Silver Trust (Ticker=SLV).
There are, however, other ETFs which do offer better odds for the investor and have much more responsible trustees. Two that come to mind are the Sprott Physical Gold Trust (PHYS) and the Sprott Physical Silver Trust (PSLV). There are similar management overhead situations in both of these ETFs, but their short interest seem to be much more under control. (At the time of this writing the short interest was 0.05% and 1.4% respectively.)
More importantly, any shareholder who has enough PHYS shares to exchange for the equivalent cost of a 400 ounce good delivery bar can do so on a monthly basis:
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So, that’s about 40,000 shares necessary for redemption in physical metal in PHYS versus 100,000 share Baskets via Authorized Participants in GLD.
It get’s better. There seems to be tax advantages PHYS & PSLV have over other ETFs:
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But even these ETFs have potentially negative side-affects. It should be pointed out that not all analysts agree and here’s one article that disses PHYS.
If you just want to play the bull market by trading paper money and don’t expect to need the physical metal in the near future, then perhaps the ETF is a vehicle you can use to book profits. Just make sure you understand that the profits (or losses) will be in paper-based fiat currencies like the U.S. dollar. And as you should already know, all fiat currencies of the world are now racing to their nominal values (=zero). This article explains why that’s happening.
It’s just better and safer to own and hold your own physical metal in your hands. Especially if a catastrophe hits the global monetary system, as could happen given the situation with the dervatives market.
Contact the author of this article by sending an email to: Jon K
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