Comparing the cost of Gold ETFs with BullionVault...

ONE OF the largest shareholders in the New York-listed SPDR Gold ETF, until recently, was noted hedge fund manager David Einhorn's Greenlight Capital, writes Julian Murdoch at Hard Assets Investor.

But last week, we learned that he'd sold all of his shares in the SPDR (NYSE Arca: GLD) in favor of physical bullion.

How much? About 4.2 million shares of GLD, or roughly $390 million. And why? "At a minimum, this will provide some savings as the costs of storing gold are less than the fees" of the SPDR Gold ETF, Greenlight told investors in a client letter.

So does Einhorn know something we don't know? Is the 40 basis points charged by GLD each year for the privilege of owning their shares a rip-off? Or a great deal?

Let's put some of the moving parts on the table, and compare the costs of trust-fund gold with ownership of the physical stuff itself.

If you are going to buy physical gold, you first have to decide where you're going to store it. But sticking a few hundred thousand dollars of Gold Bullion in a safe deposit vault at your bank is a bad idea, for one big reason: If you're buying large quantities of gold, the bars you buy will be serialized. They have provenance, and their acceptance as a thing worth a few hundred thousand dollars is based on an unbroken chain of ownership inside approved vaults. Most bars never leave the big gold vaults; ownership simply moves from one buyer to another.

How much does this custody cost? Well, that varies, but on the cheaper end of the scale, you can go to BullionVault.com, an online gold exchange that custodies just over 18 tonnes at the moment for its users. BullionVault charges 12 basis points per year to users holding more than $40,000 in gold. [Ed. Note: Below that, it's $4 per month flat...]

Once you decide where custody of your gold will be, you actually have to buy it, which means dealing with spreads and commissions in the variable precious metals market. Spreads in particular can vary massively in the precious metals market. If you're a primary dealer on the "over the counter" (OTC) market, trading in 10,000 ounce blocks, your spread could be as low as 50 cents an ounce. For retail investors looking at pooled gold programs, a quick survey of available quotes suggests a spread of about 25 basis points is the norm.

Commissions are easy to figure out.  If you're buying gold from a dealer, like Kitco.com, you won't pay a commission – because Kitco's profit is built into the spread they charge. In the case of something like a pooled account, the spread varies, but a spot check last week saw gold offered at 936.20 on the bid and 941.20 on the ask, putting the spread at $5/ounce, or 50 basis points.

If instead you choose to do the buying and selling yourself on an exchange like BullionVault, your commission works out to be about 10 basis points for a million dollars of trading – more for smaller trades, less for larger. [Ed. Note: See the full tariff here...]

So all told, your round-trip cost for physical gold is the width of the spread, plus commissions in and out, plus a custody fee. [Ed. Note: BullionVault users don't need to pay the spread if they don't wish to...]

In comparison, when buying the GLD Gold ETF, you enter the ticker into your brokerage account and, whammo presto, you're done. You pay an expense ratio of 0.40% per year and the good folks at State Street and (more specifically) their custodian (HSBC) take care of things for you, storing numbered gold bars in a vault in London on behalf of the trust in which you now own a share.

There are a few additional expenses, of course. You have to pay a commission to buy and sell shares, which can range from $5 for an ultra-discount broker to as high as 4-5 cents a share for a full-service firm.  And you have to pay the available spread, which Morningstar says averages about 11 cents per share.

N.B: For the sake of argument, I'm going to assume that over time, the GLD's premium or discount to net asset value, the NAV, isn't an issue. And indeed, the evidence is that the premium/discount is pretty normally distributed around zero.

With these ideas in place, let's walk through a thought experiment that quite a few investors might be considering right now. Let's suppose I have $1 million, and I want to Buy Gold.

What's the cheapest way? My costs will be:

• GLD: 40 bps expense ratio, 2 cents per share commission, 11 bps spread
• Bullion: 12 bps custody, 10 bps commission, 25 bps spread

Now, three scenarios. First, I bought on July 1 a year ago, and I sold at the beginning of July this year.
 

Gold ETF vs. BullionVault: July 1, 2008 - July 1, 2009
Purchase at July 1, 2008
Buy the Gold ETF		Buy at BullionVault
Price (Adjusted Close)	$92.66	Closing Price (London PM)	$937.50
GLD Investment (no. shares)	10,783	Ounces purchased	1,064
Price paid	$92.71	Price paid	$938.67
Investment	$999,702.31	Investment	$998,746.88
Commission	$215.66	Commission	$998.75
Net Cash Outlay	$999,917.97	Net Cash Outlay	$999,745.62
(Spare Change)	$82.03	(Spare Change)	$254.38
Sale at July 1, 2009
Sell the Gold ETF		Sell gold at BullionVault
Price (Adjusted Close)	$92.39	Closing Price (PM Fix)	$938.25
Book value	$996,241.37	Book value	$998,298.00
Price received	$92.34	Price received*	$937.08
Sell for	$995,693.44	Sell for	$997,050.13
		Custody @ 0.12%	$1,197.96
Commission	$215.66	Commission	$997.05
Net receipts	$995,559.80	Net receipts	$995,109.50
Closing price change	-0.291%	Closing price change	0.08%
Net performance	-0.44%	Net performance	-0.46%

At the end of the day, while the reported price of gold was just barely positive over the period, your investment in GLD would have returned 2 basis points more than your investment in physical gold on these numbers – a whopping 400 bucks on your million-dollar investment.

Of course, a minor tweak to any number of assumptions would swing this either way.  GLD often trades with spreads tighter than the 11 basis points implied here, and of course, if you're actively working your own trades on the gold exchange at BullionVault, your "spread" could be substantially better or worse.

But is either one a rip-off? Hardly, it seems. Moving the period back another year does change the math though.

Here's the same trade done 12 months earlier, for a two-year round-trip ending July 1 this year:
 

Gold ETF vs. Bullion: July 1, 2007 - July 1, 2009
Buying the GLD Gold ETF		Buying at BullionVault
Closing price change	42.09%	Closing price change	43.30%
Net performance	41.95%	Net performance	42.37%

All of a sudden, things look less rosy for GLD. My actual realized performance on buying physical gold is ahead by 42 bps. Not super exciting, but still, 42 basis points on my million bucks is $4,200 I'd rather have than not.

And what about if we go three years out?
 

GLD vs. Bullion: July 1, 2006 - July 1, 2009
Buying the GLD Gold ETF		Buying at BullionVault
Closing price change	48.59%	Closing price change	50.61%
Net performance	48.42%	Net performance	49.44%

Now the choice seems pretty clear. My physical Gold Bullion performance is more than a percent higher than my GLD position.

Thus the conclusion for us average investors is pretty clear: If you hold for a long time, holding bullion is likely a better bet. For Einhorn, a giant GLD position must have weighed on him like a lead albatross around his neck. His fund's $400 million position was costing him $1.5 million a year. That's a non-negotiable $1.5 million over which he had no control.

By contrast, a $400 million player in the bullion market has substantial room to negotiate. By making the move out of GLD, he gains instant power. He also avoids the public disclosure of GLD's 13F filing every quarter, disclosing his position in listed, publicly-traded securities whether he wants it disclosed or not.

And one interesting final note: What are the chances Einhorn sold his GLD shares on the open market? Zero. Far more likely, he negotiated with an authorized participant in GLD for a very large redemption...something smaller investors can't do below 100,000 shares, or the equivalent of some 10,000 ounces. Einhorn, however, could theoretically have taken custody over physical Gold Bullion already being held in the SPDR Gold Trust itself, with essentially zero costs.

I'm not sure we'll ever know, but it's just possible that GLD served as a convenient way for his Greenlight Capital hedge-fund to acquire an awful lot of physical gold.