In December of 1912, John Pierpont Morgan testified before the Bank and Currency Committee of the House of Representatives in Washington, DC. During this testimony, Samuel Untermeyer, Attorney for the Committee, asked Mr. Morgan about the basis of banking and specifically the following: “But the basis of banking is credit, it is not?” Mr. Morgan replied:”Not always. That is an evidence of banking, but it is not the money itself. Money is gold, and nothing else.”
In the past five years we have witnessed a tremendous run in gold from $900 to $1,900 per oz and quickly fall to $1,300 levels. There is clearly lots of interest gold investments as it provides a hedge against inflation and uncertainty as well as an alternative to assets with low real returns. So, what is the best way to own gold?
Physical ownership: Physical ownership of gold was prohibited in the U.S. between 1933 and 1974. Since 1974, many gold dealers have established their businesses in the U.S. where individuals can buy and sell gold. For many, the physical ownership remains attractive as a secure investment that provides full ownership, control over wealth, and serves as insurance against crises. But there are costs related to the physical ownership – the main one being storage. Storing physical gold may be expensive as it requires a safe deposit box in which it can be kept protected.
Gold exchange traded products: In March 2003 the first gold exchange traded product was created in Australia, and the time of the gold exchange traded funds began. The most well-known fund is the SPDR Gold Trust exchange-traded fund (GLD). It is said that GLD provides the security, low cost of ownership, and liquidity to its owners. But there is a lot of skepticism around it, with some even doubting the Fund holds the gold in its vault in London. The GLD Prospectus provides plenty of information to understand the risks involved with this fund. Few items jump out of the prospectus: 1) Ownership of the shares does not come with ownership of the gold, the Trust is the legal owner of the gold; 2) Shareholders have no voting rights except if 66% of Shareholders vote to remove the Trustee; 3) Out of 24 risk factors identified in the prospectus, five risks were related to the theft, loss, damage, destruction, or poor safekeeping of the gold that may result in losses to the investors. Clearly, GLD has its risks and the investors should not assume that owning GLD is the same as owning the physical gold.
Clearly, there is no easy answer to the question of gold ownership. It all depends on the individual circumstances, needs and beliefs. One thing to mention is that central banks clearly prefer physical ownership. Recent trends show that countries are loading up on their gold. Russia, China, Turkey, India, France have all been net buyers of gold in the past four years. And Germany, the country that kept 674 tons of gold in the Federal Reserve Bank of New York and Banque de France in Paris, asked for all its gold to be moved back to Germany in 2013. It turned out Germany hadn’t audited its gold reserves in New York and Paris, and now when there is a concern that the gold is no longer in these banks, Germany wants it all back, to be stored in Frankfurt.
Gold lease: This becomes important to keep in mind when thinking of owning gold through a fund, because someone else may potentially claim the ownership of the same gold bar. Two parties own the same bar of gold when a bank (the lessor) leases the gold bar to a bullion bank (the lessee) and the lessee sells the bar on the open market to another party. While there is a new owner of the bar, the lessor is not aware of the sale made by lessee and keeps showing a receivable for the bar on its books (London Gold Bars have serial numbers on them); therefore there are two owners of the same gold bar.
Gold ownership is something to consider, as it is a great way to diversify investment portfolio and to hedge against the inflation and currency risks. However, do the research and read the prospectus. Gold has been around for over 6,000 years and will continue being used as a store of value for its scarcity, durability, portability, and consistency. It is the only money that has survived all others in the world, and as J.P. Morgan said: “Money is gold, and nothing else.”