Another Problem With the GLD ETF

In December I published A Problem With GLD and SLV ETFs where I briefly perused the GLD prospectus. It concluded, “For these reasons including (1) the quality of the gold is at issue, (2) no audit of the physical metal is permitted, (3) counter-party risk impregnates the investment vehicle and (4) there are strong conflicts of interest with complicit players in the central bank gold price suppression scheme; GLD and SLV appear impotent in reducing inflation or counter-party risk.”

Quality of Gold
From the original article, “Page 12 “In issuing Baskets, the Trustee relies on certain information received from the Custodian which is subject to confirmation after the Trustee has relied on the information. If such information turns out to be incorrect, Baskets may be issued in exchange for an amount of gold which is more or less than the amount of gold which is required to be deposited with the Trust.” On page 11 “In addition, the ability of the Trustee to monitor the performance of the Custodian may be limited because under the Custody Agreement the Trustee has only limited rights to visit the premises of the Custodian for the purpose of examining the Trust’s gold”. Therefore, it appears that an audit of the actual physical gold is precluded (Update: See comments 25 & 26).”

Reader Comment Raises an Issue
A perceptive reader commented (#25):
But I’m not sure how you get to “an audit of the actual physical gold is precluded” from “the Trustee has only limited rights to visit the premises of the Custodian for the purpose of examining the Trust’s gold”. “Limited rights” is not “no rights”.”

If Deloitte’s statement of 21 November in the 10-K is to be believed, they have “audited the … statements of condition … [and] such financial statements present fairly, in all material respects, the financial position of the Trust”. Now I am quite ready to be sceptical about the lengths DT went to check the gold was there. But, on the face of it, they have effectively stated that the $20bn worth of gold as per the balance sheet really exists and really belongs to GLD. And it’s hard to imagine they didn’t at least send someone to the premises of the Custodian to have a quick peep, though of course in this crazy world of mediocratic financial services it is probably unwise to have 100% faith even in that. [emphasis added]

Trust Audit Rights of the Custodian or Subcustodian
The latest 10-K (Commission File Number 000-32356) on pages 26 and 18 respectively: ” Gold held by the Custodian’s currently selected subcustodians and by subcustodians of subcustodians may be held in vaults located in England or in other locations.” and “In addition, the Trustee has no right to visit the premises of any subcustodian for the purposes of examining the Trust’s gold or any records maintained by the subcustodian, and no subcustodian is obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian.”

The audit test was performed to the standard of ‘reasonable assurance’. Piecing these assertions together it could be possible for subcustodians to provide incorrect information, either negligently or willfully, to the Custodian concerning the physical gold quantity or quality. If the incorrect information came to the knowledge of the Custodian then they would issue Baskets. Regardless the Trust is unable to visit the premises and examine the Trust’s gold or any records maintained by the subcustodians. As a result, the paper instrument would inaccurately represent the represented underlying physical bullion and the error would most likely not be discoverable.

Investment in Gold Versus Gold
In the 10-K on page F-3 SPDR Gold Trust asserts an “Investment in Gold, at cost” of $16,878,554,000. The term ‘investment in gold’ is used in multiple places throughout the 10-K. This is contrasted with other terms such as ‘Proceeds from sales of gold’. This raises the issue of whether gold and investment in gold are synonymous terms?

In accordance with International Accounting Standard 1, The Bank for International Settlement’s Annual Report, under Accounting policies footnote 14, treats Gold as a financial instrument. Under Notes to the financial statements part 5 the Bank is extremely careful to distinguish ‘total gold holdings’ as being comprised of ‘gold investment assets’ and ‘gold and gold deposit banking assets’.

In GLD’s case, the financial statements make a significant distinction between ‘investment in gold’ and ‘gold’. This is odd considering most companies do not make such a distinction between similar financial instruments such as ‘dollars’ and ‘investment in dollars’ or ‘euros’ and ‘investments in euros’.

Also odd is the lack of transparency over what GLD’s ‘investment in gold’ is comprised of. Is the phrase ‘investment in gold’ broader, narrower or completely different from the term ‘gold’? For example, can a COMEX futures contract, warehouse receipt or other similar OTC derivative fall under ‘investment in gold’? The term gold is well defined as a chemical element with the symbol Au and atomic number 79. Obviously, a warehouse receipt for gold is not gold unless the receipt is made of the chemical element of atomic number 79.

Mr. Turk addressed this particular issue and concluded, “If GLD declared its asset to be “Gold”, the fund’s auditor would have to substantiate that the gold really exists, which GLD of course cannot do because of the inability to audit or even inspect gold stored in subcustodians and sub-subcustodians, which is a risk noted in the prospectus.”

Because the Trust does have some gold in their vault the auditors are most likely satisfied to a ‘reasonable assurance’ concerning the rest of the gold.

Conclusion
GLD ETF Trust supposedly holds more than 1,000 tons of gold. That amount is surpassed only by the United States, Germany, IMF, France, Italy and Switzerland; assuming they have the gold they claim. Under the GLD prospectus and latest 10-K it appears that the Trust neither needs to own actual physical gold that constitutes atomic number 79 nor allow their auditors to see and touch the undefined ‘investment in gold’. I agree with the reader who asserted that ‘it’s hard to imagine they [auditors] didn’t at least send someone to the premises of the Custodian to have a quick peep’. In other words, ‘Just trust us, the gold is there.’ But why believe them?

By: Trace Mayer, J.D. on 19 February 2009 - part 2