Do gold ETFs make safe investments?

By Paul Amery Sep 03, 2010

Paul Amery

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"No serious professional investor should own gold exchange-traded funds (ETFs)," reckons hedge fund Hinde Capital. ETFs offer "none of the benefits of physical gold ownership" and in fact may own "encumbered" gold, the firm says –someone else may have a claim on metal that you thought was yours. Hinde has its own axe to grind: it charges hedge-fund fees to own gold-related investments. Still, does the firm have a point?

In fact, the largest UK-listed gold trackers – ETF Securities' Physical Gold (LSE: PHAU) and Gold Bullion Securities (LSE: GBS) aren't ETFs at all. They are notes (debt securities) issued by Jersey-based firms, backed by holdings of bullion, and described as 'ETCs'. This choice of legal structure is down to Europe's UCITS rules, which govern investment funds. These rules do not permit a fund to invest in a single commodity, nor to own gold directly (although, confusingly, both non-EU Switzerland and the US do permit ETFs that own only bullion). So are these ways of holding gold safe?

It's impossible to generalise about fund and note structures, but most have common ground. They typically hold almost all bullion in "allocated" form (meaning the custodian holds a certain number of bars that are the sole property of the gold note or fund). So unless you believe the custodian is lying, this gold isn't encumbered. Only when there's a creation or redemption does part of the gold holding temporarily become "unallocated", representing some settlement risk to a market counterparty.

ETF Securities' website explains that in the event of its own bankruptcy, its ETCs are ring-fenced, while if the custodian of the gold, HSBC, fails, the Trustee should step in on behalf of the owners (ie, investors in the ETCs) and take control of the gold. It's fair to point out, as Hinde does, that the ownership mechanism hasn't been tested in a bankruptcy. But to suggest that gold confers none of the benefits of physical gold ownership seems absurd, given that gold ETFs and ETCs have drawn so much money in the last decade for doing precisely that.

There are other ways to own gold. Bullion Vault offers perhaps a simpler holding structure and compares well with ETFs for larger investors and longer holding periods. Or, if you're really concerned about using a financial intermediary, you can buy bullion and store it yourself – although you'll incur higher costs.

• Paul Amery edits www.indexuniverse.eu, the top source of news and analysis on Europe's ETF and index-fund market.

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Published in Investments | More articles by Paul Amery

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  • 1. marty

    (08 September 2010, 01:25AM)  Complain about this comment

    It seems to me that the article struggles to explain a relatively simple concept, and it doing so complicates matters.

    Its all about ratios and leverage. If you gold ETF has one ounce of gold for each sold, then there isn't much of a problem. If however as came out in recent commodities commission hearings in the US, some gold is leveraged up to 100 times, when you want physical, you've a 100-1 chance of actually getting it ... which is a big problem. The other problem is that the gold has effectively been oversold, so that if everyone attempted to cash out their gold, the system would collapse... Generally people try to ignore this small point.

  • 2. James

    (14 September 2010, 12:53PM)  Complain about this comment

    I am still confused: do the etf providers hold the gold or is it leveraged? Is it allocated or not?
    I would dearly like to know the truth about this.

  • 3. Will

    (27 October 2010, 04:28PM)  Complain about this comment

    I suggest actually reading the research from Hinde, all 50 pages of it: http://www.hindecapital.com/docs/hil_reports/Hinde%20Capital%20-%20Precious%20Metals%20ETF%20Alchemy%20Aug%2012%202010.pdf

    A serious investor, as Hugh Hendry urges, should look for truth. This requires such investigative work.

    I'm not sure your comments dismiss any of Hinde's claims Paul, and believe that this research is useful information an investor should add to their knowledge base.

    I would be interested to see Ben Davies reply to your article, as I think the information in his research can dismiss your claims.

    You cite Hinde having an axe to grind. Is it possible you might have an axe? Your bio hints at a proximity to the ETF and ETC world?

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