Gold-linked exchange-traded products are growing in popularity with investors. Assets held by gold ETFs have grown 38% globally in 2019.

In October, according to the World Gold Council, gold ETFs attracted $1.9 billion in net inflows to reach a new record high total gold holding of 2,900 tonnes – at least on paper.

There is good reason to be skeptical of whether all these “gold” vehicles actually hold physical metal sufficient to back their market capitalizations on a 1:1 basis. Some of them very well might; others almost certainly don’t.

In fact, many of these gold instruments hold futures contracts and other financial derivative products that merely “track” the gold price.

The biggest of them all – SPDR Gold Shares (NYSE:GLD) – purports to have 100% backing of its $42 billion market capitalization in physical bullion. But it’s practically impossible to achieve around the clock since the fund’s assets are a moving target.

As an open-ended fund, GLD doesn’t hold a fixed quantity of gold. A close inspection of its prospectus reveals that it relies on layers of financial intermediaries to create shares and manage its gold inflows and outflows.

That creates a tremendous amount of counterparty risk, including the risk that some of the gold claimed in vaults by GLD may be rehypothecated, or simultaneously owned by another party. Rehypothication is defined by Investopedia as “the practice by banks and brokers of using, for their own purposes, assets that have been posted as collateral by their clients.”

According to Chris Powell of the Gold Anti-Trust Action Committee, “The custodian of the vault holding GLD's gold is the investment bank HSBC, perhaps the biggest short in the gold market… the bank is the beneficiary of a new New York Commodities Exchange rule apparently allowing the bank to inject more ‘paper gold’ into the futures market.”

Banking and gold don’t go well together – not for gold investors, anyway. The whole point of owning a hard asset is to have wealth outside of the financial system!

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