By Tony Davis – Atlanta Gold and Coin Buyers
One of the most popular ways to invest in gold is through exchange traded funds; more commonly referred to as ETFs. There are a few reasons why individuals choose to invest in this form of gold. Most obvious is the convenience of being able to purchase shares through a brokerage account with a couple of keystrokes from a computer. Secondly, it’s possible to invest in shares that are a fraction of standard size gold coins and bars, which provides a bit more flexibility. Thirdly, the expenses associated with investing in ETFs are minimal. Lastly, the round-trip commission associated with buying and selling gold through ETFs are nominal on an annual basis.
While on the surface, investing in gold ETFs may sound like the ideal investment, the fact of the matter is that investing in gold ETFs is a very risky proposition; much more than you may have realized. In this article, we’ll share with you some of the potential pitfalls associated with investing in gold ETFs and why we believe that an investment in physical gold coins and bullion is a superior option.
Investing in ETFs is a way to invest in the gold futures market – not physical gold bullion. Most individuals that purchase shares of a gold ETF are speculating that the price of gold will go higher in the short term or are using the ETF as a hedge. When you sell your shares or exit a position in an ETF, you typically receive the cash equivalent of the total market value of your position as opposed to physical delivery of gold bullion. Only in certain situations are you eligible to receive physical delivery of your holdings. This option is typically only available for individuals or companies that own a significant number of shares, and only to the extent that physical bullion is available for delivery.
However, the fact of the matter is that most individuals that sell their position in an ETF are in search of the cash equivalent of their investment as opposed to physical delivery of the bullion. This relatively low physical delivery request allows gold ETFs to continue to operate. But as alluded to above, if needed or requested, the fund that you invest in may not have enough physical bullion on hand to meet redemption requests.
If the purpose of investing in an ETF is to hedge against a declining dollar and provide stability and security, an ETF is not a good option.
As we’ve discussed in the past, the amount of physical bullion held by the large COMEX bullion banks, such as JP Morgan and HSBC, is not sufficient to meet a large physical delivery request. In fact, at the moment, COMEX gold bullion eligible for physical delivery is at its lowest level ever at 351,519 ounces.
In isolation, over 350,000 ounces of physical bullion sounds fairly substantial; however, this compares to aggregate gold open interest of 43.5 million ounces! In other words, the current market value of ETF shares held by individuals and companies is roughly $47.4 billion. You don’t have to be a math major to realize that gold ETFs are currently leveraged at a staggering ratio of 124 to 1. Considering that Lehman Brothers had a leverage ratio of approximately 35 to 1 when it filed for bankruptcy, this is certainly a reason for concern. In fact, we believe that it’s a house of cards that will ultimately collapse when there’s a crisis or a substantial request for physical delivery.
As more individuals come to realize that gold ETFs are highly leveraged (to put it mildly), the more likely that investors will begin exiting their positions. Once individuals lose faith in the gold futures market, the gold futures price will sink like a rock, and will likely blow through any stop losses that you have in place.
How to Invest in Gold
In our opinion, there’s only one way to invest in gold, and that’s through physical gold bullion and coins. We have shared with our readers in the past various gold coin and bullion options that they may want to consider. Many gold coin and bullion options exist; however, we recommend that investors stick with low premium, recognizable and highly liquid options, such as gold bars produced by name brand mints and popular gold coin options, such as gold eagles, gold maple leaf coins, gold krugerrands and gold buffalos, just to name a few.
Your round-trip premium on these coins will be roughly 5% – 7% (assuming that you purchase your gold coins and bullion through a low cost provider), which is reasonable and actually compares favorably with the expenses associated with ETFs and mutual fund expense ratios and other fees (assuming that you plan on holding your coins and bullion for any considerable amount of time). The most important benefit with respect to investing in physical bullion is that you have the items in your possession and aren’t relying on a gold futures market that is highly leveraged and is subject to unraveling.
In summary, we have shared with you some of the potential pitfalls associated with investing in gold through an ETF.
First and foremost, rarely do ETF’s settle contracts in the form of physical bullion.
Secondly, the amount of physical bullion supporting the number of shares outstanding tends to vary and oftentimes isn’t sufficient to meet physical delivery requests.
Thirdly, gold ETFs are oftentimes highly leveraged. At this point in time, the amount of eligible gold for physical delivery is at its lowest level ever while contracts outstanding are valued at approximately $47.4 billion. The current ratio of 124 to 1 is extremely concerning and is at a level at which most companies have gone bankrupt in the past.
Considering the above, we believe that an investment in gold ETFs is a very risky proposition. Rather, we recommend that you invest in low premium gold bullion coins from recognized mints and manufacturers.