Silver and gold bugs have long been suspicious about the exchange-traded mutual funds designed to mirror the performance of gold bullion (GLD) or silver bullion (SLV). The gnawing issue about those funds is that the assets they purchase, to mirror the metals, are not guranteed to be there. San Diego County Bar member Trace Mayer discusses these problems after he reviews the prospecti of those funds. In summary, those prospecti say "Just trust us; the gold is there". Mr, Mayer is (rightfully) suspicious:
1- Potential problems with the quality of the metals:
Page 11 states “Neither the Trustee nor the Custodian independently confirms the fineness of the gold allocated to the Trust in connection wtih the creation of a Basket
Gold and silver are fungible assets and the quality is easily tested. When a broker-dealer states that they can't assure the quality of the underlying asset, that statement is on par with a supermarket offering fresh crabs but with a disclaimer that imitation crabmeat might be used in the preparation. More from the prospectus:
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”.
magine the supermarket saying that they can't assure the quality of the crabmeat because the fishermen won't let them inspect the meat before it arrives in the store.
2- Mr Mayer continues with counter-party risk. This means the fund might lend the metals out out and never get it back. The fund won't insure the metals in the vault either. This is just the sort of thing which contributed to the decline of the mortgage market. Mortgage pools were carved up, pledged as collateral, and borrowed against. No audits were made by ratings agencies.
3- A conflict of interest exists so that it might be profitable for the fund custodian to loot the assets:
From page 9 “Under the Custody Agreements, the Custodian is only liable for losses that are the direct result of its own negligence, fraud or willful default in the performance of its duties. Any such liability is further limited, in the case of the Allocated Bullion Account Agreement, to the market value of the gold held in the Trust’s allocated gold account with the Custodian, or the Trust Allocated Account, at the time such negligence, fraud or willful default is discovered by the Custodian”
I am incredibly suspicious when securities firms slice and dice assets, pair off their risk, and stand to gain financially if a collapse might occur. Again, using the mortgage-backed securities model. when the real estate market tanked, anemic securities firms (Merrill Lynch) sold distressed assets (First Franklin's sub-prime portfolio), at a deep discount to related parties, which stood to profit off foreclosing homes rather than modifying loans.
The problem with GLD and SLV, exchange-traded mutual funds, is obvious; the assets may not be there when you need them most. Physical delivery of gold and silver bullion is still the safest way to provide the proper hedge you might desire. Contact me if you have any questions.
