Gold’s ‘Paper’ Price

April 15, 2010

What's the real reason GLD trades at a discount to spot metal? The answer might surprise you.

  • Why the London PM fix matters
  • How arbitrage keeps GLD in line
  • What difference 40 basis points make


It just doesn't make sense when someone complains about the difference between the price of so-called paper gold and that of physical bullion—at least, not from the standpoint of the bullion-holding SPDR Gold Shares Trust (NYSE Arca: GLD).

Surely a difference has developed between the trust's benchmark and its share price. But that differential is much smaller than the divergence claimed by many observers. The spread's origin is benign too, and not the result of some grand manipulation.

To illustrate the issue at hand, take a gander at the comments made by a reader of a recent Hard Assets Investor precious metals story:


"The GLD ETF is trading today at 25 percent below what the spot price for gold is. In the past, these two prices traded very close to each other. This brings me to the belief that the price of ‘paper gold' is starting to disconnect from that of the physical bullion price. This reflects the recent mainstream media attention to the manipulation charges brought forward at the recent CFTC hearing in Washington.

"What we are witnessing is the start of a divergence in precious metals pricing, with two prices; one for physical gold and the other for gold derivatives—such as GLD ETF."


GLD at a 25 percent discount to spot metal? Better think again.

When gauging GLD's worth, it's important to understand that its benchmark is the London afternoon gold fix. The gold fix is a wholesale price, so it's inappropriate to compare it—and, by extension, GLD's value—against prices for retail, or small-lot, transactions.

Now, if you compare the London afternoon fix (actually, 1/10th the fixing price, as GLD's share price is pegged to a tenth of an ounce) against the contemporaneously derived GLD net asset value (disseminated once a day under the ticker symbol GLD.NV), you'll see a very tight correlation. A 99 percent correlation, in fact.

You won't, however, find the trust's NAV to be equal to the adjusted gold price. At present, the trust's NAV is at a $2.44 discount to gold. That's a 2.2 percent difference, not 25 percent.


London Gold Fix Vs. GLD NAV

London Gold Fix Vs. GLD NAV


Yes, dear reader, the difference used to be smaller. In fact, at one point, there was no difference at all between these two values. That was back in 2004 when the GLD trust was initially launched.

So what accounts for the difference? Has bullion's price actually become disconnected to the trust's value? Not exactly. The growing difference simply reflects the trust's cumulative operating expenses, just as costs accrue in other collective investments, such as mutual funds and exchange-traded funds. As gold is the trust's only asset, its net expenses, compounding at the annual rate of 40 basis points (0.40 percent), are financed through gold sales. These gold sales reduce the trust's asset base and therefore its NAV.

Are investors getting ripped off by this diminution? Again, no. Look at it this way: If you owned physical bullion, you'd need a place to store it securely, wouldn't you? As a retail customer, you'd be more than lucky to get a year's safekeeping for only 40 basis points.

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