Buckle up, this one’s going to be entertaining… because I should have called this note “Why you should always read the fine print.”
This morning I read through the prospectus and annual reports of the most popular Gold ETFs in the world.
First, some background:
ETF stands for ‘exchange-traded fund’. It’s sort of like a mutual fund that’s listed on the stock exchange, meaning investors can buy/sell shares of an ETF just like they would buy/sell shares of Apple, Ford, or (God help us) Netflix.
But unlike Apple, which is an operating business with employees, products, revenue, etc., an ETF is NOT an operating business. It’s a fund that merely pools capital to own assets.
The benefit for investors is that ETFs can be an easy and convenient way to invest in certain assets which would otherwise be difficult to buy.
If someone wants to buy Egyptian stocks, for example– they could open a brokerage account in Cairo… or buy an Egypt ETF that’s listed on the New York Stock Exchange.
The ETF is a LOT easier for most investors.
But there are also ETFs for gold and silver. And I find this mystifying.
We’re not talking about Egyptian stocks. Gold and silver are easy to buy. You could have Canadian Maple Leaf gold coins delivered to your home with a few mouse clicks.
So gold ETFs provide no added convenience.
Yet there’s an enormous amount of downside.
First off– it’s important to know that if you buy an ETF, you’re paying for a ton of unnecessary expenses.
The ETF has to pay custodian fees, marketing fees, listing fees to the New York Stock Exchange, audit fees, management fees, etc.
I’m chairman of the Board of Directors for a company that’s listed on a stock exchange, and trust me– the listing fees are REALLY expensive.
If you own physical gold in your own safe, you wouldn’t have to suffer the cost of paying lawyers, auditors, and investment bankers.
But GLD does. Which means that as a GLD investor, YOU are fundamentally paying those costs.
And remember that ETFs aren’t operating businesses. Apple makes money selling overpriced hardware. But GLD has no products, and hence doesn’t generate any revenue.
So how do they pay for this mountain of expenses?
By selling gold.
GLD trustees periodically sell off the gold (that’s supposedly owned by the investors) in order to pay expenses.
Right in its own prospectus, GLD tells us:
The amount of gold [held by GLD] will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust’s expenses”
And like I said, those expenses are NOT cheap. I’ll come back to that.
This is important because GLD (and several other ETFs) are structured as ‘flow-through’ trusts.
So when they sell gold to pay expenses, this can create hidden tax headaches for GLD investors. The IRS could treat those gold sales as if you personally had sold gold, triggering capital gains consequences.
GLD’s 2018 annual report states this clearly on page 21:
“When the Trust sells gold . . . to pay expenses, a U.S. Shareholder generally will recognize gain or loss. . .”
But aside from the excessive costs and possible tax consequences, ETFs are simply not designed for your benefit. They’re designed for Wall Street’s benefit.
GLD, for example, has a terribly complex structure involving a ‘sponsor’, ‘marketing agent’, ‘trustee’, ‘custodian’, and various ‘Authorized Participants’.
These middlemen standing between you and your gold are all big Wall Street banks who suck value from your investment.
Here’s something really incredible: with GLD, the physical gold is supposed to be held with the ‘Custodian’, which is HSBC Global.
But according to GLD’s legal documents, the Custodian has the right to use Sub-Custodians. Yet they’re not required to have any written agreement with the sub-custodians.
Those sub-custodians can then shift your gold even further to sub-sub-custodians, which also does not require a written agreement.
This is directly from GLD’s report:
“The Custodian’s selected subcustodians may appoint further subcustodians.”
“These further subcustodians are not expected to have written custody agreements with the Custodian’s subcustodians that selected them.”
This is where it gets really ridiculous:
“[T]he Custodian does not undertake to monitor the performance by subcustodians of their custody functions or their selection of additional subcustodians and is not responsible for the actions or inactions of subcustodians.”
In other words, the gold could end up with some sub-sub-sub-custodian. No written agreement is required.
And, even though the primary custodian (HSBC) is receiving handsome fees, they have no obligation to monitor the sub-custodians, nor can HSBC be held responsible if someone screws up.
Moreover, the report states:
“The Custodian and the Trustee do not require any direct or indirect sub-custodians to be insured or bonded with respect to their custodial activities…
“Therefore, Shareholders cannot be assured that the Custodian maintains adequate insurance or any insurance with respect to the gold held by the Custodian on behalf of the [ETF].”
So, not only is there zero requirement to even have a written agreement before storing your gold with some sub-custodian, there’s also no requirement to insure the gold that they’re storing.
SOUNDS LIKE ANOTHER WIN FOR THE LITTLE GUY!
Seriously, you have to be insane to buy GLD.
Sure, it’s convenient to click a button and buy GLD with your brokerage account.
But it’s also convenient to buy physical gold coins on Amazon. Jeff Bezos can deliver them to your house via drone strike later this afternoon.
Yes, GLD is liquid. You can sell shares anytime during market hours. But physical gold is also liquid. You can sell it anywhere in the world.
So gold ETFs have no real advantage.
But the disadvantages are numerous. You’re paying a ton of unnecessary expenses, dealing with potential tax consequences, and enriching big Wall Street banks who have no obligation to do anything on your behalf.