An Open Letter to the Bullion Desk

December 13th, 2004 – Lines are being drawn in the debate about the new exchange-traded fund developed by the World Gold Council, which is listed on the NYSE under the symbol GLD. Several items have recently appeared on www.thebulliondesk.com, for which I am compelled to respond lest there be any misunderstanding about my point of view on this new product.

Dear Bullion Desk:

Your recent editorial commentaries about GLD have not been helpful. They have fanned the flames by adding opinions, rather than facts, to the debate.

I am therefore pleased to see that you have removed some of this material from your website. (www.thebulliondesk.com)

One thing people can still read on your website though is the “Open Letter to GATA” by a gentleman named David Walker, which you chose to publish. Given that it is an opinion piece, rather than a factual news report, I assume that you published it because it serves your point of view, even though the letter is wrong in some important respects.

For example, regarding the Bank of England, Mr. Walker wrote: “The Fund has no relationship with the Bank of England. The Bank of England was listed as a POTENTIAL subcustodian that the Custodian MIGHT use in the normal course of business. Certainly HSBC being the largest LBMA member would more than likely have dealings with the BoE from time to time. During my conversation with the Fund representative Mr. David Smith, he mentioned that there has been talk of discontinuing the BoE as a POTENTIAL subcustodian.”

Both you and Mr. Walker should do your homework, and the fund’s representative to whom Mr. Walker spoke should be ‘called on the carpet’ for disseminating incorrect information. The relationship with the Bank of England is not a “potential” one, but rather, already in place. The following is from p44 of the prospectus: “The Custodian is authorized to appoint from time to time one or more subcustodians to hold the Trusts gold. The subcustodians that the Custodian currently uses are the Bank of England and LBMA market-making members that provide bullion vaulting and clearing services to third parties.”

It would also be useful to post a counterpoint to a news item on your website by David Elliott of Dow Jones. Addressing the discovery that GLD’s bar list has duplicate numbers, the title of his article, “Duplicate Numbers on Gold Bars Normal – Johnson Matthey“, is totally erroneous. Contrary to Mr. Elliott’s assertions, Johnson Matthey did not say that having the same number on a bar is “normal” or “standard practice”, as Mr. Elliott contends. Here is exactly what Johnson Matthey wrote. (Image of Letter from JohnsonMatthey) Clearly, it is not normal to have two bars with the same number – it is an exception.

The JM letter makes it clear that only part of the bar number was recorded by GLD. The pre-fix to the bar was not recorded in the bar list reported on the StreetTracks website.

GoldMoney, pioneered the online reporting of audited gold bars (all of the gold within GoldMoney is audited). Using GoldMoney’s bar list as an example, here is how the JM-UK bars should have been reported (note the first two bars on the list). (GoldMoney – Certificates & Reports)

To Mr. Elliott’s credit, he did quote me accurately: “The problem is that without having the ability to audit all of the assets of GLD, there is no way of verifying whether this error by GLD was a simple bookkeeping error, or whether other factors were at work.” Hence, this error of duplicate bar numbers demonstrates the need for auditing all of the gold within GLD, and not just the gold in the custodian.

So the important issue remains unanswered. Why isn’t all of GLD’s gold audited? If it were audited, simple bookkeeping errors (e.g., recording only part of the bar number) would be caught by the auditors, and corrected. And if it were anything but a simple bookkeeping error, the auditors would catch that too.

I have taken a lot of arrows in my back recently, including the ones emanating from your website, but none of the substantive questions that I and other people have asked about GLD’s basic governance – whether or not the questions were posed by members of GATA – have been answered. These include, to quote Chris Powell of GATA:

“Why have all the custodians and potential custodians of the fund’s gold not been identified?

Why is the fund refusing to let its gold holdings be fully and publicly audited?

Is any of the fund’s gold being leased, made available for leasing, or encumbered in any way? Exactly what is the fund’s relationship with the Bank of England, a major lessor of gold?“

Therefore, if independent third parties do not audit all of the gold, how are we to know that it really exists? And if we cannot prove that the gold exists with audits and inspections, how can GLD be considered as a means for investors to buy physical gold, which is how it is being popularly portrayed? The WGC explained at various industry conferences in the past that the ETFs objective was to provide investors with the means to acquire physical gold by purchasing a tradable security.

I happen to know quite a bit about this topic of using accounting to represent physical gold because we had to address this matter in building GoldMoney. Holding gold in your hand is one thing – but storing it in a vault is something altogether different. But there are risks to both. For example, is the coin you are holding really gold, or just gold-plated lead? And is the gold you store in the vault, safe and secure? To provide our customers with assurances of integrity about the safety of their gold, all of their gold is audited.

One of my GoldMoney colleagues and I discussed GoldMoney’s custodial arrangement and auditing in meetings and telephone discussions with the WGC in 2003. Further, the WGC had a whole year to act on the article I wrote in December 2003, which identified the same custodial weaknesses identified in my recent article. Why didn’t they do anything to fix the problem I identified?

Here’s a useful analogy. Not too far from where I am writing this letter there is a massive public works project called the ‘Big Dig’. It aims to build an Interstate highway by tunneling under Boston, which as everyone knows is a port city, so there is a lot of water about.

After spending $15 billion, the project is nearing completion, and it has been reported that the ‘Big Dig’ has a leak because it was not built properly. So we are now hearing from numerous experts who warned the ‘Big Dig’ builders before construction began about the unique soil conditions in the area, advice that apparently went unheeded.

The same is true for GLD. It has a ‘leak’ because it was not built properly. Gold the fund supposedly owns in subcustodians and sub-subcustodians cannot be audited or inspected to verify that it really exists.

Now, I don’t know whether ‘Big Dig’ can be fixed, but GLD can be fixed very easily. Store all of the gold bullion in HSBC, the fund’s custodian, and eliminate all subcustodians and sub-subcustodians.

In the rush to begin the ‘Big Dig’, some basic considerations were overlooked. So too with GLD. In their rush to launch an ETF, the WGC overlooked some basic building blocks, like ensuring that all of the gold owned by GLD is audited. Why the oversight? Why the rush? Why were the warnings in my 2003 meetings and December 2003 article ignored?

I will leave it to others to investigate and to get answers for those questions, but until all the basic issues are investigated and everyone’s questions are answered, it is not ‘time to move on’, though that is what you propose in a December 9^th editorial posted to your website.

In that editorial you say: “We stand by our view that it is a shame that a product that many people have worked tirelessly to get through the maze of regulation and finally to market – in response to calls for greater access to the gold market – should be subject to allegations which have not clearly helped confidence.“

What good does it do working tirelessly to get something through the regulatory process spending a reported $15 million if it is not built right? And why the innuendoes? It’s not the legitimate questions about GLD that have hurt confidence. Rather, it has been adversely affected by a fund launched with so much promise and anticipation, but turns out not to be an alternative to buying physical metal, and won’t be until all of the gold is audited. Confidence has also been hurt as the WGC’s unwillingness to answer the legitimate questions posed to them.

I explained this point to Tim Wood, ofResource Investor, who wrote: “The WGC has avoided commenting on the gold fund in any way for fear of trespassing Securities & Exchange Commission rules regarding open ended securities that are deemed to be a perpetual offering. Turk has no sympathy since he does not believe the SEC would object to clarification or reasonable communication about critical issues.” (www.resourceinvestor.com)

This point is also made in an excellent article by Ed Bugos, “GLD: Incompetence or Told You So?” His article’s subtitle addresses this key point precisely. “If it’s genuine, questions inspire confidence – once answered.”  (www.gold-eagle.com)

Your December 9^th editorial goes on to say: “For the vast majority who will be happy with that risk and want an opportunity to participate in moves in the gold price, then the new ETF provides an easy and efficient way to do it.”

I doubt if you can speak for the majority of gold buyers, but we do share a common view in one respect. GLD tracks the gold price. But the point you seem to miss is that until and unless all of the gold within GLD is audited, it cannot be viewed as an alternative to buying physical gold. Because that is what GLD was intended to do, I contend that GLD is seriously flawed because it does not provide for auditing of all of the gold owned by the fund. Without this independent third party verification there is no way to establish whether all of the gold owned by GLD really exists.

As this debate widens, new questions are now being raised about GLD. For example, in the article referenced above Ed Bugos asks, can borrowed shares of GLD be redeemed for gold? If so, who’s to stop one of the Authorized Participants from borrowing GLD shares, redeeming them for the gold bullion in the vault, and then removing that gold to lend it to earn extra income?

Let me sum up by quoting Chris Powell of GATA: “When the exchange-traded fund reports gold bars with duplicate serial numbers (even if there really are separate bars somewhere), when the fund happily declares that it may not even know the identity of the custodians of its gold, when the fund has a relationship with the biggest and perhaps most nefarious gold-leasing and gold-selling financial institution in the world, and when the fund does not forswear leasing its gold and thereby assisting the suppression of the gold price, investors generally and gold’s partisans particularly should be skeptical.”