Gold ETFs, such as the GLD ETF, are rising in popularity due to their convenience. They’re easy to trade, there’s no need to store anything, and no one is going to break into your house to steal your GLD shares. No wonder investors are weighing the GLD ETF vs. physical gold.
But there are a lot of hidden dangers inherent in the structure and operation of gold ETFs that few investors are aware of—and these risks are more pronounced than ever, as the threat of another financial crisis is always around the corner.
Considering the public’s waning trust in the banking system, many investors find themselves wondering how gold ETFs stacks up to owning physical gold. When you look at both assets more closely, it’s clear that gold ETFs and physical gold bullion are very different investments.
Why the GLD ETF Is Not the Same as Physical Gold
SPDR Gold Trust (GLD), the largest, most popular gold ETF, is an investment fund that holds physical gold to back its shares. The share price tracks the price of gold, and it trades like a stock, but the vast majority of investors don’t have a claim on the underlying gold.
The reason for this is that you can only request physical delivery of metal if you own a minimum of 100,000 GLD shares (most investors don’t: at $1,000 gold, 100,000 shares is more than a million dollars). Even if you do own enough shares, the GLD ETF reserves the right to settle your delivery request in cash.
So why is GLD appealing to investors if you never actually own any gold?
For one, the fund is both convenient and low cost. If you’re looking for an inexpensive way to invest in the direction of the gold price, GLD is ideal.
The other advantage is you can employ leverage with options, which can be risky, but it’s something you can’t do with gold bullion. If you’re an investor who doesn’t plan to take delivery and you’re comfortable with a higher degree of risk, GLD can be a good way to gain exposure to the price of gold.
Counterparty Risk on All Levels
While gold ETFs can be a fine investment, they come with a lot of counterparty risk inherent in their chain of custody. And this risk will only grow commensurately with systemic uncertainties.
Think about it: If you own GLD, you must rely on a counterparty to make good on your investment. If the fund’s management, structure, chain of custody, operational integrity, regulatory oversight, or delivery protocols break down, your investment is at risk.
It all raises too many questions. Can you be sure the bank doesn’t front-run its customers? How safe are the fund’s holdings? Is the fund protected by adequate insurance? Is the custodian bank trustworthy enough to safeguard the gold?
The best reason to own gold is as a hedge against risk. It can be your last line of defense in an economic crisis—a form of wealth insurance, if you will. But since gold ETFs are part of the very banking system you need protection from, you must ask yourself if they serve one of the primary purposes for owning gold.
In a period of financial crisis, the risks inherent in holding GLD would only rise. In fact, the frequency and severity of counterparty risks with gold ETFs are already rising.
When you consider how these ETFs function, the problem of counterparties quickly becomes apparent:
When you invest in GLD, you buy shares through an Authorized Participant, which is usually a large financial institution responsible for obtaining the underlying assets necessary to create ETF shares.
When it does so, it is buying shares in the fund’s trustee, the SPDR Gold Trust. The trustee then uses a custodian (HSBC) to source and store the gold for it.
Trust in the custodian is paramount: If you’re buying gold as a hedge against a failure in the financial system, you must be confident that the custodian would not be impaired if a crisis were to happen.
As HSBC is one of the world’s largest banks, you simply don’t have that assurance. If there’s a systemic disruption, your GLD shares would likely be negatively affected.
Custodians like HSBC can use sub-custodians, such as another bank, to source and store gold. So in addition to the risk you assume with the fund’s primary custodian, you’re now exposed to even more risk because it has added another counterparty.
There are no written contractual agreements between sub-custodians and the trustees or the custodians, which means if a sub-custodian drops the ball, the ability of the trustee or the custodian to take legal action is limited.
This leaves the trustee on the hook for any negligence. But trustees don’t insure the gold for gross negligence; they leave that to the custodian, who secures limited general insurance coverage for the contents of the vaults. The value of the gold in the vaults is likely to be much greater than this limited policy would cover.
What this all boils down to is that if anything happens to any of the counterparties, you’re the one who loses. And you have zero recourse.
How the GLD ETF's Custodian Laundered Billions of Dollars
To fully understand how quickly the security of your investment can be called into question, you don’t need to look any further than the GLD ETF.
The fund’s custodian, HSBC, which sources and stores its gold, has a sordid history of unethical behavior.
Here’s a look at HSBC’s Rap Sheet:
- fined $1.92 billion for violating laws designed to prevent money laundering and other illegal financial activity
- allowed drug traffickers to launder billions of dollars in the US, and billions more across borders to countries facing sanctions, including terror-ridden Libya
- admitted to gross violations of the Bank Secrecy Act, including failure to establish and maintain an effective anti-money-laundering program, failure to establish due diligence, and involvement in the laundering of over $881 million
- accepted $15 billion in cash across the bank’s counters in Mexico, Russia, and other countries
- paid a $275 million penalty to settle with the Commodity Futures Trading Commission for manipulation of benchmark rates used in the foreign exchange markets
- fined $470 million for abusive mortgage practices during the 2008 crisis
- faces criminal investigations in the US, France, Belgium, and Argentina for helping wealthy clients across the world evade hundreds of millions of pounds worth of taxes
Would you trust this bank with your investment?
And HSBC isn’t the only entity putting investors’ money at risk. In 2016, BlackRock, the sponsor of the gold ETF iShares Gold Trust (IAU) sold $296 million in unregistered shares of an exchange-traded fund. The fund’s management essentially lost administrative control over the fund and violated SEC regulations.
The really scary part? Watchdog agencies were asleep at the wheel. The situation only came to light because BlackRock itself alerted the SEC. Investors who bought and resold the unregistered shares may have the right to sue for damages and interest.
The Case for Physical Gold
Gold funds like the GLD ETF clearly don’t offer the level of safety people expect, especially during times of economic downturn or other financial turmoil. This is why serious investors who are looking to put protections in place for their portfolios prefer gold bullion in the form of sovereign gold coins or gold bars.
Gold bullion refers to specific pieces of physical metal held in your name and title. It is not a paper proxy for gold, but the real thing—and you own it outright.
When you own gold bullion, you can never suffer a default. There’s no counterparty to make good on a paper contract. Once you buy gold bullion, it’s yours, and it doesn’t require the backing of any bank, government, or brokerage firm.
Physical gold offers advantages that GLD can’t. In addition, there are physical attributes that make gold highly valuable, and is an excellent wealth and portfolio diversifier. No other asset has all of these intrinsic financial traits:
- Liquid – easily convertible to cash
- Portable – you can hold $50,000 in a small coin tube
- Divisible – splitting up diamonds changes their value
- Durable – how long would wheat last as money?
- Consistent – one piece of real estate is always different than another
- Convenient – copper coins of sufficient value would be too bulky and heavy
- Value dense – high value held in a small quantity
- Private and confidential – you control who knows you own it
Gold has been considered valuable for thousands of years, and it will always have value. No matter what the social, political, or financial climate has been in the world, gold has never gone to zero or defrauded an investor. It is the ultimate form of money.
A New Way to Invest in Physical Gold and Avoid the GLD ETF
The old way of buying gold bullion involved sourcing a dealer, a storage facility, and coordinating insurance, shipping, and delivery. Fortunately for investors, online platforms now exist that make buying gold as easy and convenient as trading GLD ETFs.
Investors can purchase and store gold bullion with ease using full-service investing programs that streamline everything under one roof, like Hard Assets Alliance’s SMARTMETALS® platform. These types of platforms let you buy and sell gold bullion 24/7 and manage your trading account entirely online.
Here are some of the other benefits of trading bullion on an online platform:
- A focus on sovereign minted coins and bars
- 24/7 trading and account management makes precious metals investing as easy as trading gold ETFs like GLD
- Volume pricing due to a shared trading platform with institutional investors
- The option to automate purchases lets you dollar-cost average into your position instead of chasing the market
- Availability of fully allocated, non-bank, third-party storage (a buy-and-store program) saves you from having to source vaults and coordinate delivery yourself
- Fully integrated gold IRA programs let you buy gold online, arrange storage, and assign custodial services in one simple transaction
Investors can choose to store their metal, take delivery, or sell at will. There’s no middle man, and no counterparty risk—just direct ownership of gold bullion, stored safely and fully insured.
Owning gold is an excellent way to diversify a portfolio. It protects against all kinds of catastrophe, and guards against inflation and deflation.
But the form of gold you buy can make all the difference in how well your investment performs for you. At the end of the day, your choice is to own the real thing or a paper proxy. With the emergence of new online trading platforms, investing in gold bullion is now just as simple as buying an ETF.
With ease, convenience, and automation, there’s no excuse not to make an allocation to physical gold.