Smart Paper Gold (GLD vs GC vs TGD vs ???)

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Erik T.'s picture
Erik T.
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Posts: 1234
Smart Paper Gold (GLD vs GC vs TGD vs ???)

I think most people here understand that there are benefits to holding physical gold as opposed to "paper gold", but depending on one's time horizon and investment objectives, there are also arguments in favor of paper gold, which is much more price-efficient and convenient to trade in financial markets.

Setting aside the merits of physical gold for a moment, assuming one wants to have exposure to gold price appreciation (or dollar depreciation as the case may be) through a "paper" instrument, what are the relative merits of the GLD ETF vs. gold futures (GC or TGD)? Are there other options, and what are their risk characteristics in a major market dislocation or financial system meltdown?

It seems to me that although the ETF has its drawbacks, in theory they actually have the gold. Or somebody does. Supposedly. In the listed futures markets investors are supposedly insulated from counterparty risk by the exchange, but in a major meldown situation the exchange itself could easily default on that obligation.

I can't decide whether the GLD ETF is "safer" than maintaining exposure to gold through the futures markets, and if it is, by how much?

I'm not very experienced at trading futures, and don't even know what happens if a majority of short investors are suddenly liquidated en masse by their brokers after margin calls. In theory, the investors holding long positions have to be paid by the exchange, and the protection against the exchange getting a lopsided exposure is the margin call mechanism. But if everybody is "forced to sell" at the same moment when there are suddenly no buyers, what happens? You can't be liquidated out of a position that nobody is willing to buy, and to my understanding the system doesn't account for that possibility.

Any of you gold gurus have an opinion on this matter of the relative safety of various paper gold vehicles in the scenario of a major financial system discloation? Yeah, I know, hold the physical stuff... But if you're going to go paper, which is the safest route and why?

Thanks,

Erik

 

GDon's picture
GDon
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Posts: 86
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

If one has a bullish sentiment toward gold, there are the following options:

  • Physical gold
  • Futures gold
  • Gold Mining Shares
  • Gold Exchange Traded Funds

 

  • With the current backwardation in the gold basis, physical gold is, pure and simple, the ultimate hedge against the imploding fiat-currency leverage debacle.   The physical has no counterparty risk, is fully under your control, and, because it may be in very short supply, avoids the possibility of one not actually "having" gold, when they may need it most.

 

  • Futures gold (including gold futures options) is a highly leveraged shorter-term trading vehicle, for those with high risk appetites (i.e., speculation).  It's primary advantage is leverage (about 10:1) against the "invested" capital.

 

  • Gold Mining Shares can also demonstrate a relationship to the gold price, in a magnified fashion to the physical - i.e., gold shares may rise and decline in greater percentage than gold itself.    Within the mining shares, there are a) the major players, and b) the juniors.   Both have been hammered in the recent global deleveraging which has occured since July (that, and gold is the "mortal enemy" of the fiat-currency realm....).   However, the current "paper-price" (e.g., COMEX futures price) for gold, is currently at the "cost of extraction" level ($600 - $800/oz).   At this price, many mining concerns will either lack capitalization or positive cash flow, and have been choosing to shut down production and "just sit on" their in-ground reserves.     This actually makes for a good buy-in point for bulls, however, since the downside risk is minimal.   In this regard, the majors may actually be at a disadvantage, since they may be on the wrong-side of heavy hedge positions.

 

  • The Exchange Traded Funds (ETF's), can offer easy entry/exit into the gold market, and alleviate the concern of storage (of physical gold).  Beyond that, though, it carries some risk of default.   I believe GLD and some of the other funds have warehouse verification, but that is usually verification that the gold exists "somewhere".   Whether that gold would actually find it's rightful "owners" in the event of an exchange default, is anyone's guess.  

 

James Turk - a long-time "gold bug" is very knowledgeable, and his book "The Coming Collapse of the Dollar" (2004), is an easy, but very informative read on the topic.   While the actual gold mining concerns may require personal work to update, I highly recommend it.

GDon's picture
GDon
Status: Bronze Member (Offline)
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Posts: 86
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

Just a footnote on Gold Mining Shares -

During "Depression I", Homestake Mining (originating in S. Dakota), would have turned a $1000 investment in 1929, into a $10,000 return by 1939.

In fact, gold mining shares can really blossom during deflationary periods.   This, because a) their cost of operation is reduced with the cash power and lower commodity costs, b) there is a general lack of trust in the currency (and hoarding in general), and c) the "tsunami-to-sea" calm before the "big wave", winds down the above-ground stocks - ie.., inventories get reduced. 

In general, gold mining shares can do even better in a deflationary period, than in an inflationary one.

 

switters's picture
switters
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Joined: Jul 19 2008
Posts: 744
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

Thanks for the great summary, GDon.

I know that some gold mining stocks are selling for less than the amount of cash they have in the bank!  There are some good deals out there if you know where to look.

Erik, you might want to check out clivemaund.com.  Clive analyzes the gold/silver mining stocks and makes recommendations.  It's a subscription-based site, but probably worth it if you're considering mining stocks.

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xpatUSA
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Posts: 12
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)
GDon wrote:

James Turk - a long-time "gold bug" is very knowledgeable, and his book "The Coming Collapse of the Dollar" (2004), is an easy, but very informative read on the topic.   While the actual gold mining concerns may require personal work to update, I highly recommend it.

James Turk offers a very attractive alternative - perhaps even better than the ETF's.

It's called "goldgrams" and can be seen at his site http://www.goldmoney.com

I just opened an account there (Jersey Islands, UK). Gold is owned directly (no baskets) and there are a good few other advantages. USA similar schemes appear to be less well-implemented with litigation rife and e-gold "not accepting new accounts" as we speak.

 Well worth a look, IMHO.

 Ted

Davos's picture
Davos
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Joined: Sep 17 2008
Posts: 3620
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

Hello Erik:

Madoff's Primer: I'd have a listen to the FSN news hour, I posted it on today's Daily Digest. If not hour 2 it was hour 3, the blurb was short but there are 2 "banks" shorting gold, neither could/can/will be able to cover their position(s).

Take care 

Golden Age's picture
Golden Age
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Joined: Aug 2 2008
Posts: 61
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

Another option is owning shares in Central Fund of Canada Ltd...stock symbol.....
CEF:AMEX

Central Fund owns physical gold and silver in a secure vault in Canada.  

The share price rises and falls with the spot price on the open market.  But your shares in CEF are shares in physical metal.  The fund is very liquid and shares are traded daily.  I'm a bull on gold so the shares for me are a safe way to invest.  I also own physical gold.

Personally I don't trust govt's to leave the miners alone.  In SA you never know when the mines may be nationalized by Hugo Chavez or another two bit dictator and you lose your investment.  I don't trust the environmentalists to leave mines alone in the U.S. so they can mine the ore.  

Brainless's picture
Brainless
Status: Silver Member (Offline)
Joined: Dec 9 2008
Posts: 150
Re: Smart Paper Gold (GLD vs GC vs TGD vs ???)

Having gold in an overseas fault will not help to buy bread when you stand in line at the supermarket.

Although ownership is guaranteed, being able to use it is diminished by the fact you don't have it in your posession!

I buy 'Thai' bullion, these are 96.5% pure. They are available in reasonable sizes.

** In Thailand jewelry was often used as a means to keep your value even for payment. It is an old tradition and it still is prefered when compared with paper money. Because of this every village has a gold shop that sells bullion and jewelry. They use a 1 baht coin as a measure of weight. For jewelry it has to by more than 15.16 grams to be called '1 baht' gold. For bullion it has to be at least 15.244 grams. **

 

 

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