How to Invest in Gold?

Mark O'Byrne
Dec 13, 2006

The Perth Mint Certificate Programme has advantages over ETFs for investors with a medium to long term horizon ETFs have an annual administration fee which make them uncompetitive for medium or long term investors ETFs are not direct ownership of physical gold ETFs have counterparty and custodian risk ETFs are more suitable for Speculators PMCP is more suitable for Investors seeking Diversification

Introduction
Many of our clientele and subscribers to our newsletters / articles of interest have let us know of their gratitude in informing and educating them about the precious metal markets and of the importance of diversifying into assets that have an inverse correlation to the rest of their portfolio. The majority of our clientele have taken possession of physical bullion or invested in the Perth Mint Certificate Programme or have done both. We recommend to our clientele that they do both. Investors must diversify in their entire portfolio and they must also diversify within the precious metal component of their portfolio. All the eggs should not be in any one asset class and should not be in any one precious metal investment.

We know that we have convinced many in the wider investment community and in the financial media how important it is that investors again consider the hedging and wealth preservation qualities which make gold bullion the ultimate safe haven asset. Some have recently begun to recommend the ETFs (gold and silver) as the 'easiest' or 'best' way to invest in gold. While ETFs certainly have certain advantages, particularly with regard to accessibility and liquidity, we believe that they are more suited to speculators with short term horizons than to investors.

Why Invest in Gold?
Gold is unique among asset classes as it is the only asset class not dependent on the performance of auditors, management, corporations, politicians and governments. Gold does not depend on the performance of the wider economy. When you buy gold in its physical form there is no third party liability or credit risk. Or at least there should not be. Gold has a self-intrinsic value not contingent on someone else's mere promise to pay. Thus, gold in its physical form is still the ultimate form of financial insurance. This is why the major central banks in the world still retain gold bullion as an essential component of their reserves.

Gold's primary investment purpose is as a long term or permanent portfolio holding which can be used during one's retirement, passed to children, grand children and great grand children. It is used to diversify one's investments, as a hedge against inflation, macroeconomic and geopolitical risk and as financial insurance. This is because the fundamental point of investing in gold bullion is that it is the safe haven asset which investors turn to in times of economic or geopolitical uncertainty.

What are Gold, Silver or Platinum Certificates?
Precious metal certificates are certificates of ownership issued by a sovereign government that precious metal owners hold instead of storing the actual gold. Investors thus own title, with a certificate in their name, to gold, silver or platinum bullion (or ideally a combination of the 3 precious metals) stored in a government owned mint's vault.

The Perth Mint Certificate Programme is the only government backed precious metal certificate programme in the world. The Perth Mint is Australia's oldest operating Mint, established in 1899 to mint gold sovereigns to be used as money in Australia and throughout the British Empire. The Mint is owned by the Western Australian Government and is Australia's specialist precious metals mint, producing collector and investment bullion coins and bars for world markets.

The Perth Mint Certificate Programme allows investors to own bullion in unallocated or allocated accounts. The Perth Mint is rated AAA by S&P credit rating agency and is one of the safest and securest ways to own investment grade gold bullion. There are no initial or ongoing shipping, insurance, holding or custodial fees and thus it is one of the most cost effective ways for investors to own bullion. Most investors opt to own their bullion in unallocated accounts as there are no insurance or holding fees applicable and there is the flexibility of being able to transfer to an allocated account simply by paying small fabrication fees should the investor deem it necessary. Bullion can be shipped internationally from an allocated account or from an unallocated account once it has been converted to allocated.

What are ETFs?
ETFs are exchange traded funds. The recently launched ETFs are derivatives that track the price of gold and silver. Two of the more popular are the Streettracks Gold Shares (NYSE:GLD) and in London the Lyxor Gold Bullion Securities (LSE:GBS). They can be bought through stockbrokers. Stamp duty is applicable in most jurisdictions and there is an annual administration fee of between 0.4% and 0.5% per annum. Thus every year the amount of gold or silver in an ETF share shrinks by that amount. This makes them unattractive as a medium or long term investment. They are derivative contracts and one does not own or have title to the underlying asset as one does in an allocated account or when one takes delivery. Thus they are often used by day traders, hedge funds and institutional players going long and short and speculating on short term movements in the gold price.

When one buys an ETF or exchange traded fund, one is buying a derivative or a financial instrument which derives its value from or whose price is dependent on the underlying equity, indices, commodity or precious metal. One does not directly own the underlying asset and whether ETF owners have the right to take possession of the underlying product has yet to be clarified. Nor has the procedure for doing so been clarified. In some ways, this defeats the purpose of buying a hard tangible asset and finite currency like gold. This is because the fundamental point of investing in gold bullion is that it is the safe haven asset which investors turn to in times of economic or geopolitical uncertainty.

ETFs are paper vehicles or derivatives that track the price of gold or silver. With ETF's a speculator is hoping to profit from short term fluctuations in the price of or value of gold. Thus ETFs are not assets in the traditional sense of that word. An asset is an item of property or an item of monetary value owned by an individual or institution. ETFs are a form of debenture. Unlike physical gold bullion which is held in personally allocated storage, if an ETF provider went into liquidation the investor will become a general creditor as the accounts are not allocated accounts in the investors name.

An ETF confers a possible future financial benefit on the owner but when one possesses real gold bullion in an allocated account one owns in the present a real tangible asset. In the same way that if one wants to invest in property one would generally not buy a derivative. One can speculate in property through spread bets, contracts for difference (CFDs) and covered warrants on the Halifax house price index and on indices in the US. But property like land and gold is a hard tangible asset and most investors rightfully prefer the security of directly owning their own home, investment apartments, houses and or offices. It is the physical and tangible dimension of property or 'bricks and mortar' that is so attractive to investors internationally.

Paper derivative property vehicles are better used in order to hedge. If one already has a large portfolio exposure to property one could use these instruments to 'short' the property market. Similarly some investors who have large gold bullion holdings might use the ETF to hedge themselves against pull backs in the gold price.

Nature of Ownership and Intermediation of ETF
There are many parties, intermediaries, custodians and sub custodians between you and the gold in the ETF. Doubts have been raised by respected individuals in the gold industry regarding the auditing of the gold to verify that all the gold is fully accounted for. This is the only type of fund the SEC has ever approved for the retail level that isn't required to audit the assets that are meant to back the fund.

The ownership of an ETF involves a degree of intermediation between the owner and the gold. The gold is neither owned by the investor nor in his possession. Although the shares confer a form of right to the underlying asset, legally the gold is owned by the trustees whose duty it is to defend the entitlement of the beneficiaries under the trust. The legal position is that even though it is properly allocated the entitlement to bullion still rests on the trustees' promise to pay, and on the custodians ability to do so.

Risk Factors and Indemnification
State Street Global Markets is the marketing agent of the Streettracks Gold Shares and they are indemnified from a number of risks.

As per the prospectus: "The Sponsor agreed to indemnify the Marketing Agent and UBS Securities LLC, as Purchaser in the Trust's initial public offering in November 2004 of 2,300,000 Shares, their partners, directors and officers, and any person who controls the Purchaser or the Marketing Agent, and their respective successors and assigns, against any loss, damage, expense, liability or claim that may be incurred by the Purchaser and the Marketing Agent" in connection with a range of different risks.

Indemnity is a legal exemption from the penalties or liabilities incurred by any course of action.

Some of the risk factors listed in the prospectus are

• the loss, damage, theft or restrictions on access to the Trust's gold
• the lack of adequate sources of recovery if the Trust's gold is lost, damaged, stolen or destroyed, including a lack of insurance
• the failure of gold bullion allocated to the Trust to meet the London Good Delivery Standard
• the failure of sub-custodians to exercise due care in the safekeeping of the Trust's gold
• the limited ability of the Trustee and the Custodian to take legal action against sub-custodians;
• the insolvency of the Custodian
• the Trust's obligation to reimburse the Purchaser and the Market Agent for certain liabilities in the event the Sponsor fails to indemnify them
• the lack of experience of the Sponsor and its management in operating an investment vehicle such as the Trust
• competing claims over ownership of intellectual property rights related to the Trust

These are not hypothetical risks. This is evident from the fact that the World Gold Council, the sponsor of the StreetTRACKS ETF is currently being sued by Gemini Diversified Holdings. They accuse the World Gold Council of betrayal and stealing their idea. The lawsuit alleges that the WGC took the idea for an ETF and then developed a "suspiciously similar product."

Lyxor Gold Bullion Securities have similar risk factors.

Tax Issues
For tax purposes ETFs are treated as stocks or shares and thus stamp duty is applicable in many jurisdictions. Many stock exchanges impose extra charges on each transaction. In the UK and Ireland, for example Stamp Duty applies ­ which levies an additional 0.5% to 1% on each purchase. In some jurisdictions, other levies may also apply. On the other hand investment grade gold for delivery or in an allocated or unallocated account is tax free in the majority of jurisdictions. In the EU for example, there is the EU Gold Directive which makes investments in investment grade gold bullion VAT and duty free.

Annual Charges/ Fees
The 0.40% to 0.50% per annum administration fee is the primary disadvantage of the ETF for medium to long term investors. Trust arrangements cost money to set up and to keep running, and this manifests itself in a steady depletion of the amount of gold which underpins the investment. Thus there are reductions in the amount of gold represented by each Share due to the payment of Trust expenses and the impact of the termination of the fee reduction under the Trust Indenture.

Bid/Offer Spread and Stock Broker Fees
Although the dealing spreads are smaller the brokers in a stock exchange tend to remunerate themselves with commissions. The bid/offer spread is generally some 0.20%. Stockbrokers also charge a commission. Commission levels vary widely from stock market to stock market, and from broker to broker.

Summary
Thus, the key issues facing these newly emerging financial instruments include the fact that

• they are derivatives backed by gold and not outright or titled ownership of physical bullion
• indemnification from risks
• the ongoing annual fees and expenses
• tax liabilities
• intermediation; counter-party risks to auditors and custodians

These are the primary reason why we do not recommend investors buy the ETF. We believe that ETFs are a good way to speculate on gold's spot price or to invest for the short term. But we do not believe that the ETF should be viewed as an alternative to owning the physical metal either in your personal possession or in the Perth Mint Certificate Programme.

Mark O'Byrne
Email: info@gold.ie
Gold Investments
Website: www.gold.ie

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