Golden investment: is gold really gold?

The term “paper gold” used to refer to claims for the present or future delivery of some form of physical gold.

The reason for that “attachment” to the physical asset reflected the idea that “real” or “hard” assets were quite distinct from financial claims. With the advent of gold ETNs and EFTs it is very important to examine each product offered and to identify whether it is a genuine claim on gold, would it enable an investor to take delivery of gold or is it just another financial instrument which has “gold” in its title.

For example Exchange Traded Notes (ETNs) are senior unsecured, unsubordinated debt securities that are intended to allow investors to access the returns of market benchmarks. For gold ETNs the benchmarks include the price of gold bullion, Deutsche Bank Liquid Commodity Index-Optimum Yield Gold and the S&P GSCI Gold Index. These ETNs are neither equities nor index funds. The guarantee, if one is provided, is by the note issuer, usually financial institutions.

The term “access to returns of market benchmarks “ also does not necessarily mean the close tracking of an index. For example, the Royal Bank of Scotland has issued the RBS Gold Trendpilot TM ETN (NYSE Arca: TBAR) which replicates the price of gold bullion when gold is trending upwards and trades above its 200 day moving average for 5 days, and when the price is below that average, provides exposure to the yield on a hypothetical notional 3 month US Treasury Bill. Clearly an investor here does not have any claim on physical gold.

Some Gold Exchange Traded Funds (ETFs)  do hold gold, e.g. the value of SPDR Gold Trust shares relates directly to the value of gold held by the Trust less its expenses. SPDR note that the shares do not generate any income and as it sells gold over time to pay for its on-going expenses, the amount of gold represented by each share will decline over time.

This means that the investment is in unallocated gold, that is, an investor is an owner in common with other shareholders of an undivided interest in the Trust’s pool of gold bullion, maintained in unsegregated storage on a fungible basis, without specific identification by investor.

A contrast to this is EFT Physical Gold’s reference to all of its exchange traded gold securities as “backed by allocated gold held in a vault on behalf of investors ”.

There is an interesting comparison here with the Perth Mint’s offerings of investment in gold bars. The Perth Mint is government guaranteed. If an investor buys specific bullion coins or gold bars from the Mint, these are removed from the Mint’s inventory and placed in its Depository Vault, under the investor’s account number, in a custody arrangement. On purchase the investor pays for the precious metal in the coin or bar, fabrication and a year’s storage fees. These are described as allocated or investor-specific gold coins or bars.

As an alternative the Mint offers unallocated storage where investors have purchased an interest in a pool of precious metals held by the Mint. For every unallocated ounce of gold the Mint sells to investors, it purchases an ounce from the spot market, providing 100% backing. The Mint records the purchase on its balance sheet as an asset and the unallocated amounts sold to investors as a liability. The investor only pays for the precious metal on purchase and will only have to pay fabrication charges or storage fees on electing to sell. Because the Mint is a manufacturer of gold it offers fee-free storage for the unallocated gold. There is an agreement between the Mint and the investor which allows the Mint to use the investor’s unallocated metal but this does not affect an investor’s right to sell or to request delivery in the form of bullion coins or bars.

The Mint itself has noted that investors often take a three stage approach, of which the first stage is holding unallocated gold when the external environment is stable; the second stage is a conversion to allocated gold if the external environment becomes uncertain; and the third stage of taking delivery of the physical gold occurs when investors feel the world is in a crisis.

It is worth reflecting on what an investor’s strategy could be for the “paper gold” investments described above .  Contact www.dragonwildblue.com.

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