In this article I compare two gold ETPs traded in the United States:
Both are marketed as way for investors to get exposure to the gold market through their brokerage accounts. Furthermore both trade more or less in line with one another:
(click to enlarge)
However as the chart illustrates the two funds do not trade together exactly: there are fundamental differences between the two funds, which investors should be aware of when choosing one or the other. I will detail these differences below but they come down to the following:
- PHYS gives investors a stronger legal claim on physical gold than GLD, and this makes the fund more appealing to investors who are acutely concerned with the risks of owning gold derivatives, or "paper gold."
- GLD is far more liquid than PHYS, and it more accurately reflects the spot price of gold at any given time. Thus for those who want to trade gold in whichever capacity GLD is preferable.
Specifically if you look at the objectives of each fund the difference becomes apparent. For GLD, the objective is: to reflect the performance of the price of gold bullion, less the expenses of the Trust's operations" (GLD prospectus, p.2). For PHYS the objective is as follows:
The Trust seeks to provide a secure, convenient and exchange-traded
investment alternative for investors interested in holding physical gold bullion without the inconvenience that is typical of a direct investment in physical gold bullion. (PHYS prospectus, p. 1)
There are other issues such as management fees and taxation, but the difference in terms of each funds' appeal comes down to the above.
Advantages of PHYS
1: Management Fees
GLD has an expense ratio of 0.4%, whereas PHYS has a slightly lower 0.35% expense ratio.
2: Taxation
GLD's gold is treated as a "collectible," and gains on holding GLD, even for a time frame longer than a year, are taxable at 28%. Gains from PHYS holdings are treated as gains in shares in a company: if you PHYS for longer than a year then the gains are taxed at the capital gains rate of 15% or 20% depending on your income.
3: Redemption of Shares for Bullion
The security that I highlight as the appeal of PHYS is reflected in the shareholders' right to redeem shares for gold bullion. GLD shareholders do not have this right.
4: Custody of Each Funds' Gold
The SPDR Gold Trust's gold may be held with subcustodians, which are chosen by the custodian (HSBC (HBC)). Subcustodians may employ additional subcustodians to hold the SPDR Gold Trust's gold. The trustee has no say in this. If gold that is held by a subcustodian is lost SPDR Gold Trust shareholders have limited legal recourse (SPDR Gold Trust prospectus, p. 11). Basically, if (1) the custodian gives some of the SPDR Gold Trust's gold to a subcustodian to hold, (2) this subcustodian loses or steals some or all of this gold, and (3) the custodian can prove in court that (1) was a reasonable action (i.e., HSBC had reason to believe in the competence and integrity of the subcustodian), then the custodian is not responsible for SPDR Gold Trust shareholders' losses.
PHYS's gold will be held by the Royal Canadian Mint--END OF STORY. There are no subcustodians, no games, nothing that will make you think twice.
It is highly unlikely that a subcustodian will abscond with GLD's assets. However, in a stressed market environment the simplicity of PHYS's custodial situation vs. that of the GLD can lead to a situation in which the latter trades at a substantial premium. The above chart illustrates how this took place during the crisis in Europe during the summer of 2010. Thus readers who are interested in owning gold as a safe-haven asset in preparation for a crisis scenario should consider purchasing PHYS over GLD.
Advantages of the GLD
1: Variation in the Price to NAV for PHYS
GLD trades in line with its NAV. We saw in the chart above that PHYS can deviate from GLD, and therefore from the valuation of the gold held in the trust as determined by the gold's spot price. This can reflect th following:
- PHYS has favorable tax treatment and it should therefore trade at a premium.
- The market's valuation of the aforementioned strengths of PHYS (i.e. its stronger legal claim on physical silver than that of GLD) fluctuates. So in some market climates investors might place a lot of value on, say, the redeemability of the shares for bullion, and at other times they may not value this at all.
Ultimately those interested in trading silver will find that accounting for these complexities of PHYS cumbersome, and GLD is a simple alternative.
2: Liquidity
GLD trades several million shares daily, with each share representing slightly less than 1/10 ounce of gold. PHYS trades substantially less. Volume rarely exceeds 1.5 million shares, and shares represent less than 1/100th of an ounce of gold, making GLD roughly 15-40 times more liquid, depending on the day. In a chaotic market the bid/ask spread and the supply/demand of PHYS shares will be far less certain than the bid/ask spread and the supply/demand of GLD shares. Thus for shorter term traders, or for investors who value the flexibility of liquidity, GLD is a superior silver trading instrument.
3: Options
There is an active and liquid options market for GLD. This is not the case for PHYS.
Conclusion
Clearly there are various benefits and detriments to holding each of these funds. Traders will want to purchase GLD shares whereas longer term investors will want to buy PHYS shares, or perhaps a combination of both in order to trade around a core position more efficiently.
Investors might also want to consider the Central Gold Trust (GTU). The Central Gold Trust is not very liquid, but it holds more than 98% of its assets in physical gold, and it trades at an 8% discount to its NAV, which makes it incredibly appealing for those investors who can withstand the illiquidity of the shares, or even traders who are looking for an arbitrage opportunity.
Disclosure: I am long GTU. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article. (More...)
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