Unearthed: Gold ETFs 101 — Myths, Mechanics, and Market Access | ft Amanda Krichman

Key Concepts

• Exchange Traded Fund (ETF): A pooled investment fund that trades on stock exchanges, offering investors an easy way to buy into diversified products.
• Gold-Backed ETF: An ETF where the underlying asset is physical gold.
• Authorized Participant (AP): An entity that can create and redeem ETF shares in the primary market.
• Creation/Redemption Mechanism: The process by which APs create new ETF shares by delivering underlying assets or redeem existing shares by receiving underlying assets.
• Primary Market: The market where ETF shares are created and redeemed by APs.
• Secondary Market: The market where investors trade ETF shares on stock exchanges.
• Arbitrage: The practice of profiting from price differences in different markets.
• Net Asset Value (NAV): The per-share market value of an ETF's underlying assets.
• LBMA Good Delivery: Standards set by the London Bullion Market Association for gold bars to be considered acceptable for trading.
• Custodian: A financial institution that holds and safeguards an ETF's assets.
• Subcustodian: A custodian that delegates some of its responsibilities to another entity.
• Allocated Account: An account where specific assets (like gold bars) are held and owned by the fund.
• Unitary Fee: A single management fee charged by an ETF sponsor.

Gold-Backed ETFs: Operations and Myth-Busting

This discussion delves into the intricacies of Gold-Backed Exchange Traded Funds (ETFs), focusing on their operational mechanisms, investor access, and addressing common misconceptions. Amanda Kitchman, COO of Funds at the World Gold Council, joins Joe Cavaton and John Reed to provide expert insights.

The Genesis and Role of Gold ETFs

• Launch of GLD: Twenty years ago, the World Gold Council partnered with State Street to launch the Spider Gold Shares, known as GLD, a pioneering gold-backed ETF. State Street acts as the distributor and marketing agent for this product.
• Purpose of ETFs: ETFs pool assets from various investors, offering a convenient way to invest in diversified products. In the case of gold ETFs, the underlying asset is physical gold bars.

Investor Access and ETF Structure

• Clientele: Gold ETFs are purchased by both retail and institutional investors seeking investment exposure to gold.
• Trading Mechanism: Investors buy shares of the ETF on a secondary exchange, gaining access to a proportional share of the underlying gold held by the fund. Each share represents an equal portion of the gold bars.
• Authorized Participants (APs): These entities are crucial for the ETF's functioning. They are the only ones authorized to create and redeem ETF shares in the primary market. APs are listed in the fund's prospectus.
• Creation Process: An AP delivers a basket of underlying securities (in this case, gold) to the custodian. Upon confirmation of the gold's presence, the custodian releases ETF shares to the AP.
• Redemption Process: An AP buys ETF shares from the secondary market and delivers them to the ETF administrator. Once the shares are received, the gold is returned to the AP.
• Investor Experience: For individual investors, purchasing ETF shares is as simple as buying any other stock on a regular exchange, specifying the number of shares or a dollar amount.

The Creation and Redemption Mechanism: Ensuring Market Equilibrium

• Physical Gold Delivery: During creation, APs physically deliver gold bars to the custodian. The shares are only released by the fund's trustee or administrator after the gold is confirmed to be in the allocated account.
• Allocated vs. Unallocated Gold: Gold held in the ETF is in an allocated account, signifying direct ownership by the fund.
• Maintaining Price Parity: The creation and redemption mechanism is designed to ensure that the ETF's trading price on the secondary market closely tracks its underlying Net Asset Value (NAV).
• Arbitrage for Profit: APs profit from the arbitrage opportunity created when the ETF's market price deviates from its NAV.
  • Scenario: Shares Trading at a Discount: If there's an excess supply of ETF shares, they might trade at a discount (e.g., $99 when the underlying gold is worth $100). An AP can buy these discounted shares, redeem them with the fund for the underlying gold (worth $100), and sell that gold in the over-the-counter (OTC) market for a profit. This action reduces the supply of shares, bringing the market price back in line with the NAV.
  • Scenario: Shares Trading at a Premium: Conversely, if shares trade at a premium, APs would create new shares by delivering gold to the fund and selling the newly created shares at the higher market price.
• Risks for APs: APs face risks, such as ensuring the availability of gold in the OTC market for creations. However, the presence of multiple APs per fund fosters competition and incentivizes them to maintain market equilibrium.

Addressing Common Myths and Concerns

• Physical Gold Presence: A significant concern is whether the gold is actually held within the ETFs. The speakers confirm that for GLD and GLDM, the gold is physically present. Shares are not released until the gold is delivered and allocated.
• Transparency: Each ETF publicly displays its bar list daily, detailing each individual bar held.
• Audits and Inspections: GLD and GLDM undergo annual partial and full counts conducted by independent third-party inspectors. Vaults also conduct their own regular inspections.
• Gold Lending: Gold held in allocated accounts for ETFs is never lent out.
• Type of Gold Held: US ETFs accept LBMA Good Delivery 400-ounce bars. Custodians verify that these bars meet the required standards.
• Passive Management: Gold ETFs are passively managed, meaning the sponsor companies do not directly inspect the gold bars; this responsibility lies with the custodians.
• Cost Structure: ETFs have a unitary management fee that covers various operational costs, including vaulting, insurance, inspections, audits, and regulatory compliance. This is presented as a convenient alternative to investors managing these costs themselves when buying physical gold.
• Subcustody Accounts: In cases of high demand or sourcing constraints, custodians may delegate responsibilities to subcustodians. This process still adheres to all regulations, and the gold remains allocated to the ETF's trust.

Fun Facts About Gold

• Amanda Kitchman: Gold has vast use cases beyond investment and jewelry, extending into technology and medicine. Nanoparticles of gold are used in vaccines, and gold is edible in small quantities.
• John Reed: During the California Gold Rush, even laundry services could amass fortunes by collecting gold dust from cleaning miners' garments.
• Joe Cavaton: The Aztec name for gold literally translates to "excrement of the gods."

Conclusion

Gold-backed ETFs, like GLD and GLDM, offer a secure, transparent, and convenient way for investors to gain exposure to gold. The robust creation and redemption mechanism, overseen by Authorized Participants and custodians, ensures that the ETF's market price remains closely aligned with the value of its underlying physical gold holdings. The World Gold Council emphasizes the physical presence of gold, rigorous auditing processes, and the absence of gold lending, thereby dispelling common myths surrounding these investment vehicles.