Paper gold risks

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jason
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Paper gold risks

Post by jason » Mon Sep 23, 2013 12:57 pm

Anyone who reads a lot online about gold has seen "experts" warning of a paper gold and COMEX collapse, urging people to buy physical gold.  Of course, a lot of these experts sell physical gold, so they very often have a conflict of interest.  I see a lot of people saying that the gold funds will default on gold redemptions, and I think that may be possible, but I am not planning on redeeming my IAU shares for gold.  As long as I can sell my IAU shares at a properly valued price, I shouldn't care how much gold they really do or do not have, or if they have fractional reserves, right?  But I also see people warning of a bifurcation in the gold market where paper gold will become less valuable than physical gold.  I don't understand how that can happen when the price of gold in the funds is supposed to be based on the price of physical gold.  It's all very confusing.  What are the best arguments for the potential risks of investing in the paper gold market, such as IAU?  Does GTU have a much different risk profile in this regard?  GTU seems to have nothing to do with the COMEX, so I'm not sure what could theoretically cause GTU to fail.  For my PP gold position, I currently own 80% GTU and 20% IAU, and I'm thinking about going to 100% GTU.  I like the idea of having some IAU in case I need to sell some fast, and the GTU discount is very high at that time.  I'm guessing that is not likely since I would only be selling gold after a rapid rise, and that would typically cause the GTU to sell at a premium, but anything is possible, I guess.  I don't check it every day, so on the day I realize I hit 35% gold, it might be on a downswing rather than an upswing, which means there could be a large discount on that day.

Note: I had meant to post this in the gold section and messed up.  If someone can move this to the gold section, that would be great.  I am not able to delete this message, so I'm not going to post this in the gold section, making 2 identical posts.

Thanks!
Last edited by jason on Mon Sep 23, 2013 12:59 pm, edited 1 time in total.
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Re: Paper gold risks

Post by technovelist » Mon Sep 23, 2013 1:55 pm

jason wrote: Anyone who reads a lot online about gold has seen "experts" warning of a paper gold and COMEX collapse, urging people to buy physical gold.  Of course, a lot of these experts sell physical gold, so they very often have a conflict of interest.  I see a lot of people saying that the gold funds will default on gold redemptions, and I think that may be possible, but I am not planning on redeeming my IAU shares for gold.  As long as I can sell my IAU shares at a properly valued price, I shouldn't care how much gold they really do or do not have, or if they have fractional reserves, right?  But I also see people warning of a bifurcation in the gold market where paper gold will become less valuable than physical gold.  I don't understand how that can happen when the price of gold in the funds is supposed to be based on the price of physical gold.  It's all very confusing.  What are the best arguments for the potential risks of investing in the paper gold market, such as IAU?  Does GTU have a much different risk profile in this regard?  GTU seems to have nothing to do with the COMEX, so I'm not sure what could theoretically cause GTU to fail.  For my PP gold position, I currently own 80% GTU and 20% IAU, and I'm thinking about going to 100% GTU.  I like the idea of having some IAU in case I need to sell some fast, and the GTU discount is very high at that time.  I'm guessing that is not likely since I would only be selling gold after a rapid rise, and that would typically cause the GTU to sell at a premium, but anything is possible, I guess.  I don't check it every day, so on the day I realize I hit 35% gold, it might be on a downswing rather than an upswing, which means there could be a large discount on that day.

Note: I had meant to post this in the gold section and messed up.  If someone can move this to the gold section, that would be great.  I am not able to delete this message, so I'm not going to post this in the gold section, making 2 identical posts.

Thanks!
I believe GTU says they are just holding gold without all the complications of the ETFs. I think GTU is also eligible for normal capital gains taxation, but check with your tax advisor.
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Re: Paper gold risks

Post by jason » Thu Sep 26, 2013 12:54 pm

I believe GTU says they are just holding gold without all the complications of the ETFs. I think GTU is also eligible for normal capital gains taxation, but check with your tax advisor.
Yes, I confirmed with my CPA about the fact that GTU is taxed as capital gains, not as a collectible, so GTU will be taxed at 20% instead of 28% for long term capital gains.  But that is just one benefit.  My main concern is the safety of my IAU holding.  There is a lot of talk about GLD and IAU having fractional reserves with the possibility of collapse, similar to a banking collapse.  What is a realistic worst case scenario for IAU in regards to this?
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Re: Paper gold risks

Post by technovelist » Thu Sep 26, 2013 12:59 pm

jason wrote:
I believe GTU says they are just holding gold without all the complications of the ETFs. I think GTU is also eligible for normal capital gains taxation, but check with your tax advisor.
Yes, I confirmed with my CPA about the fact that GTU is taxed as capital gains, not as a collectible, so GTU will be taxed at 20% instead of 28% for long term capital gains.  But that is just one benefit.  My main concern is the safety of my IAU holding.  There is a lot of talk about GLD and IAU having fractional reserves with the possibility of collapse, similar to a banking collapse.  What is a realistic worst case scenario for IAU in regards to this?
The worst case is that they collapse under the weight of multiple requests for the same gold, and you get hosed.
Is that likely? I don't know, but the GLD prospectus doesn't make me feel very comfortable with their business model. I haven't read the IAU prospectus in any detail but if I recall correctly, it is similar to the GLD one.
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Re: Paper gold risks

Post by jason » Thu Sep 26, 2013 10:57 pm

technovelist wrote:
jason wrote:
I believe GTU says they are just holding gold without all the complications of the ETFs. I think GTU is also eligible for normal capital gains taxation, but check with your tax advisor.
Yes, I confirmed with my CPA about the fact that GTU is taxed as capital gains, not as a collectible, so GTU will be taxed at 20% instead of 28% for long term capital gains.  But that is just one benefit.  My main concern is the safety of my IAU holding.  There is a lot of talk about GLD and IAU having fractional reserves with the possibility of collapse, similar to a banking collapse.  What is a realistic worst case scenario for IAU in regards to this?
The worst case is that they collapse under the weight of multiple requests for the same gold, and you get hosed.
Is that likely? I don't know, but the GLD prospectus doesn't make me feel very comfortable with their business model. I haven't read the IAU prospectus in any detail but if I recall correctly, it is similar to the GLD one.
Keep in mind that a large percentage of the shareholders are not eligible to redeem their shares for gold, so when people sell their shares, they are just selling shares to a new shareholder, while the actual gold doesn't move.  So, as long as iShares at least has a claim to the gold it is supposed to have, I would think the shares could keep trading, as normal.  I think they would just need to have enough gold around to cover any shareholders that qualify to redeem their shares for gold.  The IAU audit report lists all the bar numbers and the value of the gold bars audited.  There could be fraud going on, but I find it hard to imagine that iShares would risk the reputation of their entire company and all of their funds.  I think if IAU fails, iShares' name would be mud.  Same for SPDR and GLD.  SPDR and iShares have so many other funds that would suffer, I would like to think they have contingency plans in place to make sure that their gold funds don't default.  Of course, common sense doesn't always prevail.  I would have though IM Global had enough incentive to not blow itself up and steal its clients' money, but that obviously wasn't the case. 
Last edited by jason on Thu Sep 26, 2013 11:06 pm, edited 1 time in total.
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Re: Paper gold risks

Post by notsheigetz » Fri Sep 27, 2013 6:59 am

jason wrote: There could be fraud going on, but I find it hard to imagine that iShares would risk the reputation of their entire company and all of their funds...
I would have though IM Global had enough incentive to not blow itself up and steal its clients' money, but that obviously wasn't the case.
Yes, you would think that but remember who was running MF global. If I knew that a former member of the U.S. Senate and/or CEO of Goldman Sachs was running iShares I think I would get my money out of it tomorrow.
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Re: Paper gold risks

Post by technovelist » Fri Sep 27, 2013 9:55 am

jason wrote:
technovelist wrote:
jason wrote: Yes, I confirmed with my CPA about the fact that GTU is taxed as capital gains, not as a collectible, so GTU will be taxed at 20% instead of 28% for long term capital gains.  But that is just one benefit.  My main concern is the safety of my IAU holding.  There is a lot of talk about GLD and IAU having fractional reserves with the possibility of collapse, similar to a banking collapse.  What is a realistic worst case scenario for IAU in regards to this?
The worst case is that they collapse under the weight of multiple requests for the same gold, and you get hosed.
Is that likely? I don't know, but the GLD prospectus doesn't make me feel very comfortable with their business model. I haven't read the IAU prospectus in any detail but if I recall correctly, it is similar to the GLD one.
Keep in mind that a large percentage of the shareholders are not eligible to redeem their shares for gold, so when people sell their shares, they are just selling shares to a new shareholder, while the actual gold doesn't move.  So, as long as iShares at least has a claim to the gold it is supposed to have, I would think the shares could keep trading, as normal.  I think they would just need to have enough gold around to cover any shareholders that qualify to redeem their shares for gold.  The IAU audit report lists all the bar numbers and the value of the gold bars audited.  There could be fraud going on, but I find it hard to imagine that iShares would risk the reputation of their entire company and all of their funds.  I think if IAU fails, iShares' name would be mud.  Same for SPDR and GLD.  SPDR and iShares have so many other funds that would suffer, I would like to think they have contingency plans in place to make sure that their gold funds don't default.  Of course, common sense doesn't always prevail.  I would have though IM Global had enough incentive to not blow itself up and steal its clients' money, but that obviously wasn't the case.
Have you read the GLD prospectus? If not, and your hair isn't grey yet, that would probably do the job.

Seriously, it is so full of holes it is like a swiss cheese, only a lot less nourishing.
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Re: Paper gold risks

Post by Tyler » Sat Sep 28, 2013 1:59 pm

Just for perspective, I sometimes like to remind myself of relative risks.

Physical gold certainly has far less counter-party risk than a gold ETF.  But IMO the counter-party risk of a gold ETF is still a lot lower than many popular high-yield stocks, munis, and international funds.  And it's also lower than the risk to your portfolio balance if you hold no gold at all. 

It's good to be smart about where you invest your money.  Don't do it blindly.  But also don't lose sight of the big picture.
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Re: Paper gold risks

Post by HB Reader » Sat Sep 28, 2013 5:08 pm

Tyler wrote: Just for perspective, I sometimes like to remind myself of relative risks.

Physical gold certainly has far less counter-party risk than a gold ETF.  But IMO the counter-party risk of a gold ETF is still a lot lower than many popular high-yield stocks, munis, and international funds.  And it's also lower than the risk to your portfolio balance if you hold no gold at all. 

It's good to be smart about where you invest your money.  Don't do it blindly.  But also don't lose sight of the big picture.
I agree about the relative risks and remember it isn't an "all or nothing" issue.  You can hold some both ways.

Everything considered, physical gold under your control is certainly preferable but holding some minor portion of your gold allocation in an ETF or something like GTU in a retirement account can make a lot of sense for many people, both to simplify and reduce taxes and to provide some additional (though limited) amount of geographic diversification.   
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Re: Paper gold risks

Post by I Shrugged » Mon Sep 30, 2013 7:35 pm

Don't forget the risks and expenses of holding physical gold.  If you are only talking about a few ounces, then no big deal.  But if you get into real money, it's not risk-free to hold physical gold.
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Re: Paper gold risks

Post by technovelist » Tue Oct 01, 2013 9:47 am

I Shrugged wrote: Don't forget the risks and expenses of holding physical gold.  If you are only talking about a few ounces, then no big deal.  But if you get into real money, it's not risk-free to hold physical gold.
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Re: Paper gold risks

Post by smurff » Tue Oct 01, 2013 11:16 pm

Maybe that's why the insurance companies are so gung-ho about taking back the Costa Concordia.
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