The world's largest gold-based ETF, SPDR Gold Trust (NYSE: GLD), was founded in late 2004. It immediately became an instrument allowing investors to gain exposure to gold without having to transport it or look for a safe place to store the physical metal. However, few people understand how the fund really works, so let's go over the basics.
SPDR Gold Trust doesn't buy or sell gold. Rather, it creates and buys back paper shares in the company. These shares pass through the hands of various market players who trade them on the New York Stock Exchange and then either deposit or withdraw them via a corresponding number of physical gold bars from the HSBC vault in London.
For the most part, GLD tracks the spot price of gold rather accurately. A share in the fund will never be worth exactly the same as one-tenth of an ounce of gold, simply because the Gold Trust retains a transaction fee and other commissions. However, it's quite close.
You can't buy physical gold this way, though. In theory, you could exchange your GLD shares for gold and get it delivered, but in practice this proves impossible. Firstly, you need to have a permit (i.e. be either a broker or a market maker), and secondly, you'll have to convert at least 100,000 shares.
In fact, Gold Trust's service agreement is drawn up in such a way that, even if investors suddenly demand their physical gold, SPDR isn't obligated to give it to them, no matter how many shares they submit.
For this reason, it's safer to store as much of your gold as possible in the form of coins or bars – or to invest in market instruments that are backed by physical gold in their own vaults. You can use ETFs for profit, but remember that those profits exist only on paper.
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