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I Saw It Coming

I Saw It Coming

Last week, I penned an article entitled “I Like Gold I Can Touch.” In it, I explained why I prefer owning physical gold rather than surrogates, like gold-backed exchange-traded funds. Right on cue, the second-largest metal-backed gold ETF, Blackrock’s iShares Gold Trust (IAU), ran into problems on March 4 that caused its shares to become overpriced relative to the price of gold.

Oy, What a Mess

Analysts say the problem will take three business days to fix, during which time any buyers of shares will be paying too much – each share is backed by .01 ounce of gold stowed away in a vault. This extra cost, known as a premium, reached 40 basis points (0.4 percentage points) relative to the price of the largest gold ETF, SPDR Gold Shares (GLD), the fund I discussed in my previous blog. Now, this premium will persist, and might get worse, for the three days it takes for IAU to regain its composure, at which time the premium will suddenly collapse. This means that anyone who buys IAU shares during the three-day window will experience an immediate price drop on the fourth day. In other words, IAU investors will overpay and then take an immediate loss. Yikes!

So what happened? The explanation is somewhat technical. You see, ETFs balance demand and supply by contracting with specialist firms known as authorized participants (APs) that can create or remove shares from the ETF through a bartering arrangement. The upshot is that when demand for shares is high, the ETF works with the APs to create additional shares so that the price of each share reflects the current price of gold rather than the supply and demand for the shares.

The rub is that gold ETFs like GLD and IAU are commodity-backed funds regulated under the Securities Act of 1933. The rules put limits on how many new shares can be created without petitioning regulators. IAU hit the share limit on that Friday, and it had to suspend its dealings with APs. The result was the price premium on its shares.

An Object Lesson

The two takeaways from this untidy little incident are:

  1. Gold is in heavy demand right now, which is why IAU couldn’t supply enough shares to keep the share price equal to the spot price for physical gold. That high demand is good for all of us who hold physical gold, because it should result in higher prices.
  2. Owning ETFs that hold gold is not the same as owning physical gold.

Contact Augusta™ without delay to set up a Gold IRA in which you can collect physical gold and have choices about where to store it. Mess with ETFs at your own risk.

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