Turning Paper Into Gold Part 1

I have seen many more investors coming to us, saying they are selling their gold (GLD) and silver (SLV) ETFs and wanting to buy physical gold and silver. What would be there reasoning to do so?

One reason is that gold and silver ETFs should be viewed as trading vehicles and not counted as real wealth ownership. Here is what I wrote about these gold and silver ETFs in my book, “Buy Gold and Silver Safely;”

ETFs are a lower-cost way to invest in gold and have a lower expense ratio than other ETFs. But these ETFs offer only paper promises if the dollar were to collapse, as the investor does not have actual ownership of gold whereby they can take delivery by turning in their shares. What investors do have ownership of is multi-level custodians, including The Bank of New York, HSBC and J.P. Morgan, who are in control of the gold. Please note these are banks. If push comes to shove with the dollar, do you want a bank in control of your gold?

If one does trade the gold and silver ETFs, and we see issues pop up with these custodians, like with J.P. Morgan Chase’s (JPM) $5 billion plus trading loss from earlier this year, then caution may be warranted and a move to the physical metals may make sense in protecting one’s wealth. But investors in these gold and silver ETFs like GLD and SLV need to consider one other aspect to whether to buy paper gold and silver or physical gold and silver as I further point out in my book;

Something else to think about when it comes to the supply issue during a real push higher on the price of gold is, where will these ETFs get their gold? When the price of gold moves from its current second stage to its third stage of euphoria, it will be impossible for these ETFs to find the gold needed to deposit for each investor who wants shares. There are other issues that one has to consider, that relate to whether the ETF who has all that gold is at the same time leasing it out.

Gold’s 3rd Euphoria Stage

This 3rd euphoria stage is what veteran Dow Theory Letters writer Richard Russel has written about over the years where he says gold will go to “undreamed of heights.” I imagine many reading this article couldn’t have imagined 10 years ago our national debt would have reached these current “undreamed of heights” of over $16 trillion, but we already know this debt is headed to over $20 trillion in the next 4 years and that’s just using today’s projections. Since when has government ever projected anything correctly?

When we enter this 3rd euphoria stage as a result of staggering debt and an uncertain future, the premiums for the various ETFs to acquire the gold will also rise. But from the “this time it’s different” club, if gold is rising quickly in price, it will be because of a banking crisis that will make the 2008 crisis pale in comparison (remember, gold finished 2008 year over year higher in price as it has every year for what will be 12 years running at the end of 2012). The power of gold’s move higher can’t be understated. Remember, during this entire run up in the price of gold, including the year 2008 when the stock market got hammered and fear was in the air, Central Banks were net sellers of gold through the Washington Agreement on Gold. Today European Central Banks have put a cap on gold sales.

The European Central Bank and 18 other banks agreed to sell no more than a combined 400 metric tons of the metal a year through September 2014. That’s less than the annual cap of 500 tons in the current agreement, which expires Sept. 26.

The IMF in that last Central Bank agreement has decided not to sell any gold. What will Central Banks do with their paper money they create out of thin air when all currencies devalue at a faster pace? Will they become net buyers?

Banks In Control of Your Gold – Read the Prospectus

Banks needed bailing out just 4 short years ago and collectively hold more sub-investment grade derivatives today than they did in 2008. So much for the Financial Reform Act. Does anyone not think that J.P. Morgan, king of the sub-investment grade derivatives today, and their $5 billion loss from July was anything but a bet they made with no counterparty to it? But if you stick a London whale’s name to it or fire a V.P., all is well right? These banks are the folks who are the custodian of your gold and silver held with ETFs people. While you are pondering that, there’s more to consider.

The Prospectus of GLD for example is full of loopholes for the Sponsor and Trustee including the following (these are all listed right in the prospectus);

1. Suspending the right of redemption
2. May not have adequate sources of recovery if its gold is lost, damaged, stolen or destroyed and recovery may be limited, even in the event of fraud
3. The Trust is not registered as an investment company under the Investment Company Act of 1940 and is not required to register under such act. Consequently, Shareholders do not have the regulatory protections provided to investors in investment companies.”

I have covered the lack of insurance by the gold and silver ETFs previously in Is The Gold and Silver Held By ETFs Insured?

When trading for profit in the precious metals market, if you are good at it, the gold and silver ETFs for now are a good vehicle to do so. If you are buying gold and silver ETFs to protect your wealth, then you might consider hedging with personal ownership of some physical gold and silver.

In Part 2 of Turning Paper Into Gold I will cover the U.S. Dollar/Euro relationship and how it could affect the price of gold, the derivatives unwinding that is occurring with no potential counterparties, and finally stock market valuations (or devaluation) and how Exter’s Pyramid holds the key of what’s to come.


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About Doug Eberhardt

Doug Eberhardt is a 28 year financial services veteran and precious metals broker selling gold and silver at 1% over wholesale cost. Doug has written a book to help investors understand how gold and silver fit into a diversified portfolio, how to buy gold and silver, and what metals to buy. The book; “Buy Gold and Silver Safely” is available by clicking here Contact phone number for Buy Gold and Silver Safely is 888-604-6534


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