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Going For The Gold
Christopher Helman, 03.11.09, 06:00 PM EDT
Forbes Magazine dated March 30, 2009

As the world's troubles mount, gold glitters brighter. The SPDR Gold Trust is an easy way to play, but not the cheapest one.

The world's biggest owners of gold: the governments of the U.S., Germany, France and Italy, and an exchange-traded fund. The SPDR Gold Trust (nyse: GLD - news - people ) owns 82,000 gold bars weighing 400 troy ounces each. That $31 billion worth of bullion is stashed away in an HSBC vault in London. If the metal were in a single cubic lump, it would measure less than 13 feet on a side. But, for convenience's sake, it's spread out over a space somewhat larger than a basketball court. "I have personally seen and held the gold," says James Ross, managing director at State Street Global Investors, which markets the trust.

The notion of owning a time-tested physical store of wealth is appealing when stocks are sinking and even government bonds look risky. Alongside stocks' 24% decline, gold has climbed 5% this year to $920 per ounce. GLD is one of the easier ways to own the stuff. It has taken in $9 billion in new investor money over the past three months.

The Gold Trust was set up in 2004 by the World Gold Council, a trade group for the metal's miners. GLD has helped keep the miners busy. In the past year it purchased 15% of the world's mine output of 2,400 metric tons. "We surveyed investors and found that they weren't [previously] buying gold because it was too difficult to access," says Natalie Dempster, the council's investment chief.

Buying GLD may be easy, but the most extreme goldbugs don't trust it or any other investment they don't hold in their hands. Such fears are not without basis. Franklin Roosevelt ordered Americans to sell privately held gold to the government in 1933. The Federal Reserve paid out $20.67 per ounce for 500 metric tons. Most private gold that escaped the cull was illegally hoarded outside of banks and custodial vaults. A hidden coin turned a fat profit when a year later Roosevelt devalued the dollar by raising the fixed price of gold to $35 an ounce.

Unfortunately for gold investors, there are no low-cost ways to buy and hold the metal, as there are with, say, an S&P 500 index fund. If you want to fill your home safe, you buy coins or bars from dealers, who typically tack 5%-to-10% markups onto the spot price. When it's time to sell, you can easily lose another 5% or more to markdowns. That's because the buyer must either undertake assay work or take some risk that your bars are adulterated with a cheaper metal.

Even so, some fanatics insist on gold they can hold. The Internet is rife with GLD conspiracy theories. One questions whether the trust's metal stash exists. The chatter is fueled in part by the trust's prospectus, which states it "does not insure its gold" and that "trustees may have no right to visit the premises of any subcustodian for the purposes of examining the trust's gold or any records maintained."

"Someone on the Internet accusing us all of being involved in a Ponzi scheme is irresponsible," says State Street's Ross. "We don't insure the gold, but HSBC does." The World Gold Council's Dempster adds that every six months a random list of serial numbers for 10% of the trust's bars is produced and the bullion physically audited. "We cannot lease or lend or write derivatives on any of it," she says.

With GLD shares you suffer the same bid/ask spreads and brokerage commissions you would on any ETF. GLD also charges 0.4% in annual fees. For the World Gold Council and State Street, that represented $25 million each in fee revenue last year, plus another $13 million for custodian HSBC. With demand for shares soaring, those figures are likely to more than double in 2009.

The trust pays these expenses by selling gold from its own store. That reduces the amount of metal underlying each share--from 0.1 ounce at the time the shares were initially offered to 0.098 ounces today. Meanwhile, the GLD share price ranges between 1% above and 1% below the net asset value of that gold.

This opens up an arbitrage opportunity for Goldman Sachs (nyse: GS - news - people ), Merrill Lynch, UBS and the handful of other broker-dealers authorized to create new GLD shares. They do so by delivering roughly five tons of gold to the trust's HSBC account and receiving in return 100,000 shares. They then wait for a relatively fat premium to NAV to open up, sell the shares into the market and pocket the difference.

Such vigorish is still a far sight less than you'll pay to own Central Fund of Canada (amex: CEF - news - people ), a 47-year-old closed-end fund. Traded on the American Stock Exchange and backed by $1 billion in gold and $700 million in silver bullion, it sells at an 11.7% premium to net asset value. Taking advantage of the premium, it regularly sells new shares. It has pledged to sell metal and buy in the shares if their discount to NAV ever reaches 20%.

Cheaper than either: gold futures on the Comex division of the New York Mercantile Exchange. If you feel confident, as little as $5,100 in a margin account will get you a contract for 100 troy ounces, says David Megar, head of metals brokerage at Alaron Trading. If you reach out six months at a time, you'll have two round-trip transactions a year, each costing just 0.01% in commissions and spreads. For long-term players, tax treatment of futures is worse than that of a fund. Futures are taxed as if they were sold every Dec. 31, with gains (or losses) assumed to be 60% long-term (with a favorable tax rate) and 40% short-term.

FORBES


Going For The Gold


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