Tuesday, November 17, 2009

Fool's Gold

It was inevitable.  The rising price of Gold has allegedly spurred a growing counterfeiting industry.  The most common method is to fill a Gold Bar with Tungsten, a metal that costs only $10 per pound.  Tungsten is very similar to Gold in that its specific gravity, or density, is nearly identical to Gold.  Thus, unless you can measure weight very, very precisely, fake Gold might  not  be straightforward to detect.

Reports are surfacing of fake gold bars. Ethiopia allegedly purchased a rather large consignment of Gold which it then sold to South Africa. As the report goes,  South Africa learned that this consignment was nothing more than Gold plated steel. An investigation found that Ethiopia  had itself purchased it from a counterfeiting ring. 

There is also a report that a Chinese investigation uncovered 1.3 million or so of these fake bars which were being manufactured by a well funded and sophisticated operation and that 640,000 of these bars sit in Fort Knox today.  Would that explain why an audit of Fort Knox has not been done since the Eisenhower Administration?

In addition, numerous suspicious reports have arisen with the Gold ETF (GLD).  An ETF is a mutual fund that trades in such a way as to mimic an index or basket of securities.  GLD, which was designed to mimic the price of Gold, has grown to huge proportion and claims to be backed by physical gold.  Its market capitalization is approaching $40 Billion Dollars.  Reports have surfaced of irregularities regarding its holdings.  For example, last September and October, several observers of GLD's holdings noted that the length of the list of holdings went form 1381 pages to 200 pages and then back.

Bill Murphy, who writes a must read letter on Gold topics at http://www.lemetropolecafe.com/, was to my knowledge, the first person to raise this issue in a serious way.  He speculated that the Rothschild's exit from the Gold market  in 2004 was incredibly suspicious.  And, coincidentally, a short time later, GLD was launched. 

This brings up some serious issues.  One is that the practice is likely to grow as the price of Gold rises and one needs to be  especially careful about buying bulk gold or investing in Gold through the GLD ETF.

Now, I'll be the first to admit that I can't independently verify any of these incidents, but, it makes sense that it has been tried and is growing.  The good news is that bulk coin counterfeiture is, so far, rare and there are entities like the Professional Gold Grading Service or Numismatic Guaranty Corp. to protect unsuspecting collectors of rare and much more valuable pieces.

Personally, I believe this has gone on to some extent, at the very least. Counterfeiters replicate art which requires one to obtain "Certificates of Authenticity" and we KNOW that currency counterfeiting has been around for decades.

Tungsten does have a flaw that differs it from Gold.  It is much harder than Gold, which is soft.  Remember the old west when folks bit into Gold? It also has vastly different properties of electrical  and thermal conductivity. But the expertise to employ these tests is not readily available to just everyone.

In addition to avoiding the GLD ETF, I would highly advise NOT purchasing on EBAY, which has a buyer beware policy. I still favor buying high quality Gold and Silver mining stocks, which, to my knowledge have never been accused of selling fake product.  There have been shams and the failure of certain companies who have claimed things like overstating their reserves.  However, if a company has an independent audit of reserves, referred to as a 43-101, you're probably on safe ground.  Nevertheless, the portfolio should be well diversified as these companies are prone to adverse events like nationalization. Two ETFs allowing investors instant diversification exist. One of these is GDX, which invests in the larger companies.  My personal preference is GDXJ, which invests in a fairly large basket of intermediates and juniors, the smaller up an coming companies.

As always, I welcome your comments, pro or con and questions.

Marko's Take

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