Europeans raise gold stakes

(Image courtesy www.gold.org/)

I have previously stated that European gold demand has been strong. The World Gold Council Gold Demand Trends for the second quarter of 2017 provides some hard data to confirm just how much it has grown.

While a comparatively small percentage, possibly only one percent, of people worldwide actually own bullion-priced physical gold, a much larger number think they own gold by trading paper forms that are more convenient.

As one paper form, people are able to purchase shares of gold exchange traded funds. Typically, such a fund is established with an initial share value equal to 1/10th of a troy ounce of gold that, theoretically, is represented by physical metal in the custody of the fund. As the ETF sells more shares, it has to acquire more physical gold to cover that obligation. Or, if shares are redeemed, the ETF needs to reduce its physical gold holdings. This appears to many investors to offer a more convenient way to theoretically own the physical metal without the bother to themselves of taking physical possession. Over time, though, the expenses of operating the fund gradually make each share worth less, so that they represent less than 1/10th of an ounce of gold.

There are several reasons why I have concerns over the practicality of owning gold ETF shares instead of the physical metal. First, if you read a gold ETF prospectus, you are likely to learn that the entity does not verify the physical existence of all the gold it supposedly owns. Instead, it relies on statements received from sub-depositories that they are really holding the metal on behalf of the ETF, but the main depository does not audit the accuracy of the statement.

Second, the prospectus is also likely to include a statement that the ETF is authorized to lease out some of its holdings. To the extent that it does, it may not have the physical metal to back up its outstanding shares, and it also has some risk of default that gold may not be returned at the end of a lease.

Third, ETFs can have complicated tax structures. This may result in those who own such shares having to pay personal income taxes on the basis of the trading activity of the ETF even if the shareholders themselves did not buy or sell any shares during a tax year.

Fourth, while the ETF may offer the theoretical ability to demand delivery of the underlying physical gold, it is only available if conducted in extremely large quantities that almost no investors can afford. So, the practical result for most investors is that it is not possible to obtain the physical gold directly from an ETF.

For these and other reasons, I consider the ownership of a gold ETF to be somewhat risky and not all that appealing as a substitute for directly owning the physical metal. At most, I would consider it a useful trading tool for very short-term purposes.

The World Gold Council’s 2nd Quarter 2017 Gold Demand Trends are available online at the organization's website (see link in text below).

Despite my misgivings, the fact is that many people do own shares of gold exchange traded funds – many times more than the number of people that directly own the physical form. At the end of June 2017, the World Gold Council reports that gold ETFs worldwide own 2,313 tons (74.4 million troy ounces) of gold. Of this, European-based gold ETFs held 977.71 tons (34.4 million ounces).

When you consider that European-based gold ETFs only held 570.14 tons (18.3 million ounces) of gold at the end of 2015, that shows that demand for shares in them has increased more than 71 percent over the previous 18 months. The largest surges in European investor demand came from Germany and the United Kingdom.

This rise in demand was not just a one-time event. The increase in gold held by European-based gold ETFs rose in five of the six quarters since the end of 2015.

As I have previously explained, there is a lot for Europeans to be worried about. Here’s just one example. Many major European banks (as do some in the U.S.), for instance, own Greek government bonds. They are required to carry them on their books at 100 percent of face value even though these bonds trade at substantial discounts. The circumstances are such that it is virtually certain that these bonds will not be paid off at full face value. Therefore, the financial condition of a lot of European banks is a lot shakier than the public is being told.

In June, Mario Draghi, the head of the European Central Bank, claimed that the Eurozone was experiencing solid growth across many member nations. Yet, at the same time, he said that the ECB would continue quantitative easing (i.e., inflation of the money supply), which would only be done if there were concerns about a weak economy.

When Europeans get mixed messages about the financial stability of their continent, they see through the official claims that all is well and seek the safe haven of gold. Americans would be well advised to do likewise.

To read the World Gold Council’s 2nd Quarter 2017 Gold Demand Trends, go to http://www.gold.org/research/gold-demand-trends/gold-demand-trends-q2-2017#package.

Patrick A. Heller was the American Numismatic Association 2017 Exemplary Service and 2012 Harry Forman Numismatic Dealer of the Year Award winner. He was also honored by the Numismatic Literary Guild in 2017 and 2016 for the Best Dealer-Published Magazine/Newspaper and for Best Radio Report. He is the communications officer of Liberty Coin Service in Lansing, Mich., and writes “Liberty’s Outlook,” a monthly newsletter on rare coins and precious metals subjects. Past newsletter issues can be viewed at http://www.libertycoinservice.com. Some of his radio commentaries titled “Things You ‘Know’ That Just Aren’t So, And Important News You Need To Know” can be heard at 8:45 a.m. Wednesday and Friday mornings on 1320-AM WILS in Lansing (which streams live and becomes part of the audio and text archives posted at http://www.1320wils.com).