Gold ETFs: prudent investment or paper dream?

Almost all market and bullion analysts in the recent years harped on a new investment option — the Gold Exchange-Traded Funds (ETFs). Till a decade ago, there were no easy options to invest in gold like the equities market. Realising this, innovative people brought out the gold ETFs to make gold investment easy for investors. The development of the gold ETF market in 2003 changed the way people invested in bullion.

Now, gold ETFs are an efficient way to invest in gold without dealing with the troubles of holding the physical metal.

Gold ETFs are traded just like shares of stock. You can buy and sell a gold ETF just as easily as shares of any company. And they trade on major stock exchanges including New York, London, and Sydney. However, some gold ETFs buy and hold the physical bullion, while others invest in futures contracts.

But when the gold ETFs came into the market, nobody anticipated a fraud will spoil the image of ETFs within 10 years of its existence. So, last week, when the Commodity Futures Trading Commission (CFTC) heard a case regarding manipulations in bullion market by gold cartels, the gold ETF scam hit the investors like a bolt from the blue.

Now, the gold ETFs’ image is at stake. Soon, investors are set to question the credibility of the gold ETFs. The reason is the facts emerged during the CFTC hearing.

The whistle-blower in this biggest gold fraud was Andrew Maguire, an experienced precious metal trader in London. In an riveting interview (which is available on the internet all over the world) with GATA director, Adrian Douglas, Maguire describes a new dynamic impacting gold. The fact is that, there is a huge short position in the market.

The CFTC hearing confirmed what GATA has been saying all along, that the gold market is being manipulated. And, how? The gold cartel has accumulated a huge short position and the huge short positions are ‘naked’, which means these positions are not hedged. There is 100-times more paper-gold outstanding than physical gold.

So, if you are buying ETFs, be sure that there is no gold guarantee for your piece of paper which offers you the ownership of some specific quantity of the yellow metal. In reality, it is just a piece of paper which you bought paying huge sums.

Recently, the World Gold Council reported that the world’s total gold ETF market grew 85% relative to 2008.

During the hearing Adrian Douglas of GATA said: I would just like to make a comment. We are talking about the futures market hedging the physical market. But if we look at the physical market, the LBMA, it trades 20 million ozs of gold per day on a net basis which is 22 billion dollars. That’s 5.4 Trillion dollars per year. That is half the size of the US economy. If you take the gross amount it is about one and a half times the US economy; that is not trading 100% backed metal; it’s trading on a fractional reserve basis. And you can tell that from the LBMA’s website because they trade in “unallocated” accounts. And if you look at their definition of an “unallocated account” they say that you are an “unsecured creditor”. Well, if it’s “unallocated” and you buy one hundred tonnes of gold even if you don’t have the serial numbers you should still have one hundred tonnes of gold, so how can you be an unsecured creditor? Well, that’s because its fractional reserve accounting, and you can’t trade that much gold, it doesn’t exist in the world. So the people who are hedging these positions on the LBMA, it’s essentially paper hedging paper.

Bart Chilton uses the expression “Stop the Ponzimonium” and this is a Ponzi Scheme. Because gold is a unique commodity and people have mentioned this, it is left in the vaults and it is not consumed. So this means that most people trust the bullion banks to hold their gold and they trade it on a ledger entry. So one of the issues we have got to address here is the size of the LBMA and the OTC markets because of the positions which are supposedly backing these positions which are hedges, but it is essentially paper backing paper.

So the giant Ponzi trading of gold ledger entries can be sustained only if there is never a liquidity crisis in the real physical market. If someone asks for gold and there isn’t any the default would trigger the biggest “bank run” and default in history. This is, of course, why the Central Banks lease their gold or sell it outright to the bullion banks when they are squeezed by high demand for real physical gold that can not be met from their own stocks.

Gold ETFs brought in 27% returns in last one year

Global media is full of stories hailing how safe is investments in gold and gold-related funds. But, even as the world is going gaga over the impeccable track record of gold as a safe haven during calamities and recession, there are sceptics who argue that this may be just a bubble waiting to burst soon.

Last week, global research firm GFMS waxed eloquent on the prospects of gold soaring to $1,100 per ounce and it forecast a solid gain for gold prices.

And, investors, after reading the robust gold rise, are putting more and more money into gold hoping to reap rich dividends at a time when the world is undergoing sever recession.

Such a situation is not at all surprising considering the fact that the gold is selling above $900 per ounce now. Remember around six years ago gold was at $325 per ounce.

But, one thing all the investors should remember is that the gold prices are soaring because of the presence of gold exchange traded funds (ETFs) and gold stock funds.

If you track the record of gold ETFs, you can see that during the past one year from April 1, 2008 to April 2 2009, gold ETFs brought in around 27 per cent returns while the equity fund category returned -36.76 per cent.

To add to that, across the globe equity market is down and in the recent weeks only the stocks started moving up. In India, Sensex started showing the rising trend while in US Wall Street also started climbing up following the stimulus packages announced by the Obama administration and G20.

Even when you are attracted to the allure of gold, there are certain worrying factors. The important issue isn’t whether an investor should consider investing in gold, but rather the logic behind it. Gold has been historically viewed as a safe haven. But that bit of wisdom does not seem to hold ground anymore. Due to the flooding of gold ETFs, the metal is now more of a paper asset whose value is increasingly driven by the demand and supply of paper gold on financial markets.

In March 2009, NASDAQ Dubai launched the region’s first Sharia-compliant tradable security backed by gold. Named Dubai Gold, it is the first ETF to list on NASDAQ Dubai.

In the first six weeks of the year, the buying by gold chasers drove more than 200 tonnes of gold bullion into SPDR Gold Shares, the world’s largest gold-backed ETF representing more than 1,000 tonnes of gold.

Gold ETFs have driven up investment demand because of the ease with which individuals may invest in the commodity. As a result, gold is now clearly subject to the same volatility as other financial assets, as investors’ interest flows in and out.

Again, according to experts, gold did not appear to be a great hedge against falling stock prices. When the global financial panic was at its peak in October 2008, gold prices were at their recent lows. International gold prices peaked in March 2008 and, from then till the end of October, gold fell by about 25 per cent.