Investing With Jay Today

March 6, 2009

Gold, Central Banks, 
the GLD ETF and Risk


Gold and central banks

Ted: I read recently that some central banks - Germany's Bundesbank, Russia's, China's - are either buying gold or slowing down their sales.   What does this tell us?

Jay: The central banks are net sellers of gold under the 1999 Washington Agreement on Gold (see also Dawn of a New Gold Market), although there could be some who are buying. If in fact they are buying more than in the past, that suggests to me that they realize the increasing intrinsic value of gold relative to the dollar. Frankly, I don't see how anyone could come to a conclusion other than that.

Ted: So, do you think that even back in 1999 the central banks were moving towards bringing back a gold standard?

Jay: No, just the opposite. At that time they were moving away from a gold standard, and wanted to set up an orderly way to gradually sell their gold with least negative effect on the gold market.

Ted: Why would they want to do that?

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Jay: For forty years the central banks have hated gold because they want people to accept their paper. Most of that time they saw their gold sit there and earn no interest. Much of that time dollars were earning good rates of interest. They were young Harvard type graduates, schooled in Keynesianism. Yet they had huge reserves in gold which grew out of the sound money days. So, a non-disruptive transition out of gold into dollars made sense in their minds.

Ted: The Gold Anti-trust Action Committee (GATA) claims that the Washington Agreement simply allowed central banks to sell their gold to the bullion banks which had in fact, already leased it.  This allowed central banks to account for the sale of gold which they no longer had possession of. GATA claims that no independent audit of Ft. Knox gold has been done in 50 years, so bullion banks weren't required to return their leased gold by purchases of gold on the open market.  If they were, the price of gold would have gone up and caused the value of national currencies to fall. Do you agree with GATA?

Jay: It sounds reasonable, but I am unfamiliar with details of the Washington Agreement.

Ted: Do you think the gold standard will be an issue at the April 2nd G20 financial summit in London?

Jay: In my opinion, it should be. But I have no idea whether it will be. 

GLD, the gold ETF

Ted: According to Fred Hickey, the SPDR Gold Shares ETF (GLD) started in 2004, and the purpose of the ETF was to give investors an easy way to invest in gold (rather than holding it themselves). The Trustee of the GLD ETF is the Bank of New York. The custodian of the gold (held in vaults in London) is the giant HSBC Bank. They have the bars in storage, but shareholders cannot take delivery like they can with a futures contract. The GLD ETF is supposed to follow the movement of the gold spot price, but it tends to be slightly lower. What is your opinion of this ETF?

Jay: I personally think GLD and SLV are wonderful vehicles for small investors who want to get started accumulating gold and silver, especially in IRAs, 401-Ks, or other tax-deferred accounts.  Actually there is a provision for taking delivery of the gold, but it has a minimum which is a rather large sum. I'm not sure of the amount. To date, it is my understanding that the ETF has tracked gold far closer than 10% on average. But you must understand that every year they take out a management fee of .5% (I think that's the amount). Therefore, each year, the price of GLD will fall an additional .5%, but still track very closely the following formula: (gold price) X [1- .005n], where n is the number of years the ETF has been in existence. Likely the .005 annual charge would be similar to a storage charge for physical gold.

Ted: I heard from Fred Hickey that GLD is becoming so popular, that it has had to add 229 tons in only the first seven weeks of 2009. Compared to 150 tons added in all 52 weeks of 2008, this seems incredible. He said that all the gold mined in the world in 2008 was 2,385 tons, so at the rate it's going, it might absorb 70% of the 2009 gold mine production. What does this mean?

Jay: I suppose it means a number of things, including the rising awareness of gold as a means of protecting ones wealth. A whole new group of investors who are buying gold and silver for the first time. GLD is even a great vehicle for pension funds, hedge funds, sovereign wealth funds, and other larger investors. There are only about 5 billion ounces of gold mined in all history, which is, of course, still above ground. Now try to imagine the total amount of all the paper currencies in the world (not a single one backed by any form of tangible wealth, and increasing by leaps and bounds year after year). If a fraction of 1% of that money decided to move into gold...we're back to Doug Casey's analogy of trying to put Hoover Dam through a garden hose.

Ted: Who are the people buying the GLD ETF? 

Jay: How about 25 million ordinary Americans (or Chinese or Japanese, etc) who want to invest $100, or $1,000 or $5,000 in gold with the click of a mouse.  One thing we are reasonably assured of is that gold investing is starting to go mainstream. Before 2006, the mainstream analysts widely considered people who buy gold to be nutcases. If you weren't following the financial news media in the early 2000s, you can't even imagine how gold was disdained. It wasn't just ignored, but actively made fun of on CNBC. Who knows? I've suggested several potential buyers above.

GLD risk

Ted: How about risk? I heard that GLD has been legally structured in a way which makes it impossible to determine if the gold in storage is being leased. This could be a problem if the Custodian becomes insolvent. In that case, the shareholders of GLD have no legal ability to seek recovery of bars leased out to subcustodians. Does this mean everything depends on the success and faithfulness of HSBC? 

Jay: There is no doubt. GLD is a paper claim on gold (physical bullion held in trust by GLD). A claim will always be inferior to owning gold outright that is in your own physical control. The GLD opponents are right on this point. But some of their far-fetched theories defy all logic and reason, ranging from GLD does not really buy any physical gold, to being a conspiracy of anti-gold forces that use the capital to actively short gold and retard its bull. You can read volumes of material on this, as well as very logical refutations of them. It's all out there.

Ultimately, any investment boils down to a leap of faith. I own several mining company stocks, but I've never actually seen their mines. Do these mines really exist? I could go visit them, and they could still be frauds, even if they looked sound to me. I'm not a geologist. I own some gold coins. They look genuine, but how do I know they are not lead clad with gold? The dealers have tools designed to detect coins that aren't the right size and weight. But what if the dealer lies? What if the government mints are not using as pure of gold alloys as advertised? There are no assurances in any investment. In my opinion, GLD needs no more of a leap of faith than I've already placed in stocks and coins.

Ted: The GLD Prospectus says, "The Custodian is required to use reasonable care in selecting subcustodians, but otherwise has no responsibility in relation to the subcustodians appointed by it, and the Custodian is not responsible for their selection of further subcustodians. The Custodian does not undertake to monitor the performance by subcustodians of their custody functions or their selection of additional subcustodians. The Custodian is not responsible for the actions or inactions of subcustodians" (p. 44) "In addition, the Trustee has no right to visit the premises of any subcustodian for the purposes of examining the Trust's gold or any records maintained by the subcustodian, and no subcustodian is obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian." (p.37) Doesn't this make you prefer to hold physical gold?

Jay: That language is required by the SEC. The most important function of a prospectus is to be sure the prospective investor understands he can lose his money.  Again, nothing is for certain in this world, but the segregated custodial account system has been working well for 200 years. Even when the banks which operate them go bankrupt, the assets in the segregated accounts are safe. I do not know any statistics on losses, if any have occurred.

I have never seen GLD's London vaults. And if I did, I couldn't know for sure if the gold I saw was really pure gold and if it was really owned by GLD. Nevertheless I do believe GLD's claims. It reports to the SEC like a stock. It has external auditors with physical access to its vault which is run by the elite global bank HSBC. Serial numbers of all the bars are posted on the Internet and regularly audited.  The London gold market, the world's largest, believes GLD is legitimate. You can't claim to buy 1029 tons of 400-oz bars in London over 4 years, and have sophisticated London gold traders believe it without the odds being high that GLD is legitimate. GLD deals exclusively in 400-oz good-delivery bars. Central banks alone own tens of thousands of metric tons of gold in this form. As Adam Hamilton points out, GLD is no Bernard Madoff, one man or a small group of insiders controlling everything in secret. GLD is a big operation directly affecting thousands of financial professionals, in many organizations, in many countries.

Having said all that, in the final analysis, every investment is an act of faith. Diversify your risks, set your limits, follow your allocations, and above all, commit all to God. If you don't get conviction and peace from Him, don't act.

Ted: You hold over 30% of your life savings in gold and silver. What percentage of that is physical metal?

Jay: Currently over 95% of my gold and silver are physical, coins, bars and one pool account at the Canadian Royal Mint. But a few months ago, that percent was about 80%. It will vary, especially during times when I am arbitraging using ETFs and other paper forms of precious metals. In addition, about 12% of my portfolio is in mining shares, which is a paper form of holding gold and silver.

Ted: How do you recommend investors store their gold and silver?

Jay: Each one must be at peace with his own method. Currently I use a private storage company. I am considering moving a portion to my bank safety deposit box. Also considering putting a safe in our home. There are some good articles on this. I¡¯m not up on all the options. You can tell I¡¯m not that concerned with diversifying mine, or I would already have done so. Just being honest. As always, commit it to God and develop your own convictions.

Note: In August 2009, Jay O'Keefe decided that GLD and SLV were no longer the optimal means of holding paper gold and silver.  Instead, he recommends CEF, GTU and SVRZF, and he has encouraged all his readers to make any necessary switches out of GLD and SLV.  This is primarily due to the character of the men who manage these three funds.  It is also because on September 21, 2009, COMEX gold futures contracts will begin satisfying some future contract delivery with ETF shares instead of physical gold.  For more information on this see Massive Institutional Gold Market Change and The Nature of Deception, Usury, and ETFs. Furthermore, as of August 2009 SVRZF appeared to be an excellent opportunity for arbitrage.  For more information see A Great Way to Increase the Safety and Potential of My Silver.

Jim Rogers, gold and the IMF

Jay: Oh, by the way, I heard Rogers (day before yesterday) recommend GLD for small investors who want to get started investing in gold. (Watch the second half of the 5 minute CNBC video.)  Several of my other experts have recommended both GLD and SLV. I have owned GLD in the past, and own SLV currently. I plan to use both to arbitrage with CEF and other forms of precious metals if the opportunity arises. But I have my limits, my allocations and rules, and I have conviction and peace.

Ted: Jim Rogers said that if the IMF sells their gold, it will be the last opportunity to buy cheap gold, but the IMF web site says they do not plan to sell their gold (see IMF Gold Sales - FAQ).  Do you think Jim Rogers knows something about this most people don't know?  Do you trust the IMF web site?

Jay: Jim Rogers said, ¡°IF the IMF does sell some of its gold and drive the price down, you¡¯d better buy all the gold you can, because that will be the last opportunity to buy gold in a long time¡± I have no idea whether the IMF is truthful, nor what Jim Rogers knows or doesn¡¯t know about them. Here¡¯s my position: I would love for something to bring the price of gold down 20% or more, and give us what could be the last great opportunity to buy gold at a super bargain price before it explodes up to $2,000 or higher (my guess). I have mentioned that to God.

References for further study:


Jay O'Keefe is a retired investment consultant.  Ted Spaeth is an English tutor.

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"Well done, good and faithful servant; you were faithful over a few things,
I will make you ruler over many things.  Enter into the joy of your lord"
(Mt. 25:21 NKJV)

If you have not been faithful in the unrighteous mammon, who will commit to your trust to true riches?" (Lk. 16:11 NKJV)

The Apostle Paul wrote, "Now godliness with contentment is great gain. We brought nothing into the world and it is certain that neither can we take anything out. So having food and clothing we will be content with that. But those who want to get rich fall into temptation and a snare and into many foolish and harmful desires, that plunge people into ruin and loss; because the love of money is a root of all kinds of evil; in their greediness some have been led away from the faith and have impaled themselves on many distresses." (1 Tim. 6:6-10 NKJV)

This information is public domain.  Jesus said, "Freely you have received, so freely give." (Matthew 10:8b)

The information in this article is the responsibility of Jay O'Keefe and Ted Spaeth, but all your decisions are your own responsibility.

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