A Look at the Gold and Silver ETFs (Part I)

It's been about nine months since the gold and silver ETFs were examined in comparison to spot prices and prices paid at coin shops (see Volume II, Issue 43) and this week's update seemed to be as good a time as any to have another look. This has always been an important subject to me because I've owned precious metals in various forms for many years now and, since I plan to continue to do so for the foreseeable future, I'm always interested in minimizing expenses.

There will come a day when I'll want to sell just about everything I've got, but that day is very far off.

For some time now, I've been expecting to see a meaningful separation between the gold and silver ETF prices and other bullion prices and you can now clearly see that happening in the charts below.

The significance of this separation will vary for each individual as this is just one part of the equation when it comes to deciding how you want to own precious metals. There are many other factors to consider as discussed in January of this year when the Buying Bullion article was revisited (see Volume III, Issue 5) and I continue to favor holding the physical metal up until storage issues become a problem. The convenience of the ETFs, however, make them attractive choices as well.

As I recall, the last time I did this, the gold and silver ETFs were sort of tacked on to the end of a review for all commodity ETFs in the model portfolio and maybe didn't receive the attention they warranted. This time, particularly in light of the data presented in the charts below, a more thorough review is provided.

Gold Bullion, the GLD ETF, and Gold Coins

The last time the chart below was updated, there wasn't really much to talk about as it was noted that the three prices seemed to track each other "rather well, going back more than a year and a half." The same can be said when looking at the chart below with two years and four months of data, though coin shop and spot prices (in green and blue) now appear to be rising above the GLD ETF (in red) just a bit.

Last time, even after looking at the differences between the three over time using moving averages (necessary because these are very noisy data series) there were no meaningful divergences. At the time I noted, "gold coins are typically $12 or $13 over the spot bid price in London and the GLD ETF x 10 works out to be around $5 less than the London close. As would be expected, the GLD ETF x 10 does show a barely noticeable trend lower relative to the spot price - on the order of one or two dollars per ounce, per year - but this seems like a reasonable price to pay since they are storing the metal for shareholders."

The chart below tell a very different story and nearly all of that story has developed since last fall.

The difference between spot gold and GLD (in red) has increased from about $5 per ounce to just over $10 per ounce and seems to have stabilized in this range - that's a significant change of over five percent of the price of gold. Looking at the information provided for the ETF (see the SPDR website for details), the fund's expenses are 0.4 percent per year, which, for $900 gold works out to be $3.60, so this is within a dollar or so of what might be expected, particularly after the stability relative to spot prices for nearly the entire year of 2007, however, it does make you stop and think.

If this trend continues (which it likely will), in addition to transaction costs, GLD holders will pay $3 to $5 per ounce per year for storage and, unless the fund's expense ratio is reduced (which it likely will), this bill will go up as the price of gold rises. For the model portfolio's x ounces of gold, that equates to almost $y in fees per year, every year, and it's easy to see how this would quickly scale up into the many hundreds of dollars per year with a larger position.

This has always been one of the key reasons why I continue to hold the physical metal.

As for the difference between the coin shop price and GLD (in blue), I've come to learn recently that there can be widely divergent prices between coin shops and that CNI has been generally raising their buy and ask prices relative to spot prices, whereas, other coin shops have not. You can see this in the difference between the coin shop price and the spot price above (in green).

So, looking at the chart, you could say that CNI has raised their buy price relative to the spot price by $5 per ounce over the last year (in green) which accounts for about half of the increase (over that same time period) between their buy price and GLD shares (in blue), the other half being the decline in GLD relative to spot prices (in red).

This makes for a rather compelling case to hold the physical metal over the long-term. Because of their small size, gold coins are easily stored in relatively inexpensive safe deposit boxes (~$50 to $70 per year) along with other valuables and home safes are another viable option.

But, remember that you pay a premium when you buy gold coins.

For example, the current buy price at CNI is $974 per ounce but their sell price is $994 per ounce. So, if you bought a one-ounce coin and immediately sold it back to them it would cost you $20 or just over two percent. When compared to the ETF as discussed above, this two percent equates to a few years of GLD expenses but, after that, gold coins are the clear winner.

Full Disclosure: Long one oz. gold coins and GLD at time of writing.

Comments

[dieuwer]

The holdings of the gold ETFs may be seized by the government. Then you have nothing left, just a paper certificate. Bullion in private ownership is the way to go, but be aware of "escheatment"...

[enviro111]

I sell call options against my GLD shares. This generates a little income every month. I roll forward or backward to capture the short term time periods.

My physical gold holdings cannot generate income. I view these as extremely long term asset holdings - maybe the rest of my life??

I find once I have bought physical gold or silver, I find it is very difficult to sell it (there are very few coin dealers anymore). One must keep it long term just for convenience. The GLD ETF can be bought or sold regularly and conveniently.

The real issue with gold ownership isn't storage (media likes to dwell on this and make it sound like a big, big deal - It isn't for most people).

The media also likes to make it sound like gold is too volatile for most people - this is more bunk too. Based on long term standard deviations of price action, it is less volatile than most stocks.

The media also likes to make it sound like gold transactions have huge spreads and commissions. Compared with most stocks this is certainly true. However, compared with other forms of tangible assets (real estate, art, collectibles, etc.) the spreads and the buy/sell convenience are quite low.

[bowman711]

dieuwer, Isn't there a Constitutional Amendment against the government taking property without fair compensation?

I know it is easy to wonder if there even is a Constitution by the way gold is being manipulated by the (government backed?) bullion banks . . . but I don't think the Constitution has been completely suspended.

[deuxsous]

enviro111:

Good point about selling options on GLD. As you clearly know, this is how long term gold owners cover their expenses and generate some income on their gold. I made a good bit of money during the long bear market selling call options to the ever hopeful. The GLD listing makes it much easier to do that these days, as you are doing.

[bold4gold]

Bullion, coins, and the ETFs are all good because the us dollar will fall another fifty percent. The gov't just can't keep bailing out freddie, fannie and those still to come. We need to protect ourselves!

[jessiejeff]

I have sold 100 oz silver bars on Craigs List for several years and never had any problems. You can always get the "ask" spot price so you come out 3-5% better than what a coin dealer will pay you. I keep the bars in my bank's safety deposit boxes and make the transfer in the bank's parking lot.

[deuxsous]

Most banks have a safe room and can even escrow exchanges like that. They do it for jewelry examinations and sales. That might be safer than a parking lot.