June 12, 2006 – My interview in the May 29th edition of Barron’s prompted the following letter from Stuart Thomas, who manages the gold exchange-traded fund sponsored by the World Gold Council (NYSE symbol: GLD).
To the Editor: James Turk asserts that exchange-traded funds, streetTRACKS Gold Shares in particular, “don’t audit the gold to prove it really exists.” Turk’s statement has absolutely no basis in fact. He has repeatedly made this spurious claim and one has to question his motive for doing so. The truth is that the gold is held in allocated form, which means specific numbered physical gold bars registered in the name of the trust held within the accounts of the custodian, HSBC.
The Securities and Exchange Commission and the Sarbanes-Oxley Law require management to assess and report on the effectiveness of internal controls. Our auditors are required to report on our representations.
Our internal controls and outside audit processes include an independent physical count of the gold, which takes place twice a year. The trust employs BSI Inspectorate, an independent firm, to count the gold and provide certificates of the count. The trust employed Ernst &Young to review and test these physical count procedures as part of their obligations under Sarbanes-Oxley.
In connection with its assignment, E&Y visited the vault to test audit controls and procedures and to observe the physical count in October 2005.
Our independent registered public accounting firm, Deloitte & Touche, rendered unqualified opinions on the internal controls for financial reporting and on the financial statements. Its auditing procedures included physical observation of the gold held at our custodian, plus confirmations from our custodian and BSI Inspectorate of its existence. Stuart Thomas, World Gold Trust Services, New York City.
Barron’s asked if I wanted to reply, which I of course did. But Barron’s heavily edited my reply with the result that in my view much of the pertinent information was omitted. You can read in Barron’s online version my reply with their edits, but here is what I wrote in total:
Mr. Thomas states that “E&Y visited the vault” and that there was “a physical observation of the gold held at our custodian”, as if only one vault were involved. However, the prospectus discloses that in addition to gold stored with the Custodian “Gold may be held by one or more subcustodians”, “the Custodian and the Trustee do not require any direct or indirect subcustodians to be insured or bonded”, “neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians”, and “Gold held by the Custodian’s currently selected subcustodians and by subcustodians of subcustodians may be held in vaults located in England or in other locations.”
It is noteworthy that the 10K records the principal asset of the fund as “Investment in Gold”, and not simply “Gold”. I point out this distinction because auditors are responsible for verifying that assets exist. If the asset were recorded as “Gold”, the auditor would need to inspect the vault of the subcustodians to prove the gold there really exists, but the prospectus discloses: “the Trustee may have no right to visit the premises of any subcustodian for the purposes of examining the Trust’s gold or any records maintained by the subcustodian, and no subcustodian will be obligated to cooperate in any review the Trustee may wish to conduct of the facilities, procedures, records or creditworthiness of such subcustodian.” Neither Mr. Thomas nor the fund’s 10K discloses the weight of gold stored in the subcustodians, which presumably could be all of the Trust’s gold.
Regarding the auditor’s “obligations under Sarbanes-Oxley”, the prospectus does not represent that the gold, whether in the Custodian or subcustodians, is audited or verified by an independent third-party to prove that it exists. Thus, it is reasonable to expect that the auditor would provide an unqualified opinion.
Lastly, though Mr. Thomas questions my motive, it is clear and straightforward. I wish to use my significant experience in this area to highlight the risks one incurs by buying paper representations of gold rather than gold itself.
Respectfully, James Turk
Readers of these letters know that I have nothing against ETFs. They can be a useful tool, but just like any tool, ETFs have to be put to the right use.
As it is presently structured, GLD should not be viewed as an alternative to owning physical metal. There are too many parties between you and the gold, assuming of course that all of it really exists. Notwithstanding the protestations by the promoters of GLD, the fund’s prospectus and 10K provide enough disclosure for one to reasonably doubt whether all the gold the ETF purports to own really does exist, that it isn’t double or triple counted, and is stored in some relatively politically safe country.
So use the ETF as a trading tool if you would like, much like you would use a futures contract – to speculate on the gold price. But just as it is clear that a futures contract is not an alternative to owning physical metal, neither is GLD an alternative to owning the real thing.
The key point to remember is that physical gold – and not just some paper representation purporting that you own gold – is the bedrock asset in your portfolio. This gold is the ultimate form of liquidity and therefore provides you with a safe haven. In this role, your physical gold takes on a high level of importance.
Consequently, you do not want to take any risk with your gold. So do not mistakenly believe that GLD meets that need for your bedrock asset anymore than you would think a futures contract fulfills that critical role for money that is not contingent upon anyone’s promise. Physical gold is one thing; paper representations of gold are something entirely different.
So buy coins and bars and/or use a company like mine, GoldMoney, to buy and store your gold for you. Then if you also want to speculate on the gold price by trading paper gold, buy GLD or a futures contract.
Where do ‘gold’ certificates issued by mints and banks fit in? And what about pool accounts? They too are paper ‘gold’. They are liabilities of the companies that issue those promises to you, which means that you need to evaluate the creditworthiness of those companies and the reliability of their promises. But regardless how good those promises may be, they are not physical gold. So paper promises do not meet the needs of your bedrock asset. The guiding principle is that a paper promise is not gold.