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Summary HSBC, custodian for the SPDR Gold Trust’s gold, is closing its 7 gold vaults. SPDR Gold Trust investors should be aware that their gold might be on the move and that they are not necessarily protected if it is lost or stolen en route. Traders might consider shares in the iShares Gold Trust for the time being as an alternative without this added risk. Longer-term investors in gold are encouraged to invest in funds that specify the location of their gold and who’s in charge of guarding it. My readers might recall a couple of articles I wrote in 2013, in which I suggested that gold investors consider alternatives to the SPDR Gold Trust (NYSEARCA: GLD ), namely the Central Gold-Trust (NYSEMKT: GTU ) or the Sprott Physical Gold Trust (NYSEARCA: PHYS ). There were (and still are) several reasons why long-term gold investors should choose these funds over the SPDR Gold Trust (although I conceded that the SPDR Gold Trust was a better trading vehicle, given its liquidity and superior gold price tracking), but one that stood out in particular was custodianship. The SPDR Gold Trust has HSBC (NYSE: HSBC ) as its custodian, but HSBC doesn’t specify where it keeps its gold. Furthermore, HSBC doesn’t have to retain its custodian status of the fund’s gold. If it chooses to – and SPDR Gold Trust shareholders have no say in this – HSBC can call on sub-custodians to hold the fund’s gold. The only stipulation is that HSBC deems that the institution is suitable as a custodian of the fund’s gold although the stipulation in the prospectus is extremely vague. Furthermore, HSBC is not responsible in the event that a sub-custodian loses the fund’s gold so long as it can prove in court that it was acting in the best interest of the fund’s shareholders. I never stipulated that there was any sort of fraud, but it seemed that the language was broad enough so that it wasn’t impossible. Considering that there are other funds that offer exposure to gold, and considering that these funds’ prospectuses are very clear regarding the custodianship of their respective gold hoards, it seemed fairly straightforward to go ahead with one of these two other funds. What’s Happened Since? Just recently, there has been a development in this situation that has prompted me to issue a cautionary note to shareholders of the SPDR Gold Trust. HSBC is closing each of its 7 London gold vaults. Now, there is no evidence that SPDR Gold Trust gold is found in any of these vaults, because HSBC doesn’t have to disclose the location of the fund’s gold. After all, HSBC is a massive international banking conglomerate with other gold vaults, including in, say, New York. Furthermore, we don’t even know whether HSBC is acting as the trust’s custodian, because, as we’ve seen, it can hire a sub-custodian to do the work. But if we look at the simple facts, it is clear that the trust’s counterparty risk will rise as a result of this, and the trust’s shareholders need to at least consider them should they choose to continue to hold on to the shares. If the trust’s gold is held in one or more of these London vaults, then when they close in a couple of months, the gold will inevitably have to be moved. Whether it is to a sub-custodian’s vault or to another HSBC vault, there is added counterparty risk in the fact that this gold will have to be shipped. This means it will come into contact with numerous people, and it might even be shipped over water where a ship could sink or a plane could crash, thereby leading to a loss of the gold. Again, let me remind investors that HSBC is not responsible for losses so long as it can prove that its actions are in the best interest of trust holders in court. This means that if HSBC puts some gold on a plane and it crashes into the ocean, then this gold is gone and the shareholders will suffer, not HSBC. What Investors Should Do Announcements such as this should remind investors to study very carefully what it is exactly that they own when they own an ETF, especially one that is supposed to own a physical commodity such as gold. This gold will sometimes need to be handled and shipped, and this means risk to the fund’s shareholders. So in the past, I have suggested investors look at the other gold funds although short-term traders would be fine in the SPDR Gold Trust. Given the upcoming vault closures and the added counterparty risk – as minute as it might be – I think gold traders would be wise to suspend trading activities in the SPDR Gold Trust. There are alternatives. The iShares Gold Trust (NYSEARCA: IAU ) will not be impacted by this. This is an $11.25/share issue that trades several million shares per day, meaning that there should be plenty of liquidity for most traders reading this article. Options are less liquid for this fund relative to the SPDR Gold Trust, so that could be an issue. I also think investors would be wise to at least consider the less liquid Central Gold-Trust as a trading vehicle, which keeps its gold in Canada and which currently trades at an incredible 7.8% discount to its NAV. This is a $40/share issue that trades nearly 50,000 shares daily, so there is nearly $2 million in daily volume. Most retail investors should have no liquidity issues, and the fund is therefore an acceptable trading vehicle for the time being unless you are looking for very short-term intraday trades. The Bottom Line Maybe I’m being a bit paranoid in my warning, but I really do think there is a risk here. While it is probably a remote one and while it is impossible to quantify, those who trade the SPDR Gold Trust should have it in mind and watch out for more news on this front over the next few months. Finally, I want to reiterate that I think knowing where your gold is and who is in charge of protecting it is important, and for this reason, I think the Central Gold-Trust and the Sprott Physical Gold Trust both offer investors with better, safer opportunities. This statement is especially true when we consider that part of the justification for holding gold in your portfolio is that it is a safe asset that comes with limited counterparty risk. Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. (More…) The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article. Scalper1 News
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