Surprise! A Close Look at GLD Reveals What it IS and is NOT (+3K Views)

The most common misunderstandings regarding the primary gold ETF, SPDR Gold Trust (NYSE:GLD) is that it buys and sells gold. That is not the case. It is just a paper asset. It is not a way to buy gold and have someone else store your holdings for you. It is just an innovative way to “own gold.” [Below I outline more of  just what GLD is and is not:]

The SPDR Gold Trust ETF burst upon the scene in November of 2004 and was immediately latched on to as a means of riding the gold bull market without the inconvenience of having to transport and securely store actual bullion…

[Below I outline just what GLD is and is not:]

1. GLD shares are only paper assets

It can’t be stressed enough that GLD is a paper asset. It is not a way to buy gold and have someone else store your holdings for you. What it does do is create and redeem paper shares in the company. These are passed through a group of market makers, who trade them on the NYSE, then deposit into, or withdraw from, the HSBC vault in London the corresponding amount of physical bullion, in the form of 400 oz. London Good Delivery bars…

2. GLD deals only in “baskets” of 100,000 shares

Even the above description is somewhat misleading. GLD deals only in “baskets” of 100,000 shares, with the goal being for the share price to track gold’s market value as closely as possible. Since each share represents slightly less than a tenth of an ounce of gold, that means each basket must trade close to 10,000 ounces of gold – and that would be impractical if the buying and selling had to be done on the open market.

3. GLD gold existence can not be personally verified

So how do they pull it off? Well, what actually happens is that the gold is moved either in to or out of the GLD-allocated section of HSBC’s vault, i.e. to or from another section of that same vault…Beyond that, we don’t know much, and you will not be allowed to see the vault, whether or not you are a GLD shareholder and no matter how many shares you own…

4. GLD shares are only valued at approx. 97.4% the price of gold bullion

A GLD share will never be priced exactly at the value of a tenth of an ounce of metal, simply because the trust deducts transaction fees and other expenses, but it is close. During August of 2011, for example, the net asset value of a share of GLD varied from 97.3635 to 97.3867% of the gold price, as fixed each day at 10:30 a.m. New York time.

5. GLD shares are not redeemable in physical gold

It is true that, theoretically, you can convert your GLD shares to physical gold and take delivery of it but, in practice, you can’t because:

In other words, if there were a sudden run on physical gold, GLD is not contractually obligated to provide actual metal, in exchange for however many shares, to anyone. [Given the above,] our position has always been to hold as much gold in coins and bullion as you comfortably can and use the ETFs to generate profits if you like, but make sure you realize that all of those profits will be of the paper variety.

6. GLD share profits (long-term) are taxed at 28%

Furthermore, there is the little matter of taxation…GLD shares, although they trade like stock, are not stocks in the same sense as Apple (AAPL) shares, [for example.]. Not when the taxman cometh. If you buy shares of Apple and hold them long term, for more than a year, then sell them, you are taxed at the prevailing capital gains rate, currently 15%. Gold, however, is considered a “collectible.” If you buy gold coins, for example, and hold them long term, then sell them, your tax liability is at the rate for collectibles, presently 28%. If you sell them for a short-term profit, you’re liable for taxes at the same rate as for ordinary income, which is determined by whatever bracket you’re in.

Of course, GLD shares are not gold, as I’ve just taken some pains to point out. Ah, but here’s the rub. GLD is structured as a grantor trust, not a mutual fund. A grantor trust is ignored for tax purposes so that the investor is treated as owning a pro-rata share of the underlying holdings, not the entity as it exists on paper. That is to say, if GLD were a mutual fund, shares would be taxed at the normal capital gains rate, but because it is a grantor trust, its long-term gains are taxed at the applicable rate for the gold it holds … which is 28%.

This situation leads to some rather odd tax peculiarities. Say your ordinary income is in the 25% tax bracket. You’re actually better off selling GLD shares short term than you would be if you held them long term and got pushed into a 28% liability.

7. GLD is an innovative way to participate in gold “ownership”

For ordinary investors GLD represents a way to (indirectly) participate in gold “ownership” without the hassle of actually taking physical delivery and finding a suitable place to vault your metal. Plus, there are no storage fees, bid/ask spreads, threats of theft, or dealer markups to worry about.

8. GLD shares allow one to play the market

Finally, for those who like to really play the market, GLD shares are amenable to all the tricks of the securities trade. They can be optioned, shorted, hedged, bundled, margined, whatever. Little wonder GLD is so wildly popular.

Conclusion

Use GLD if you are of a mind to. Just be certain you understand what it is you are dealing with.

The comments above & are edited ([ ]) and abridged (…) excerpts from the original article by Doug Hornig 

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