Dear Reader,

The New York Times had a piece today about Steve Jobs’ lack of philanthropy. He’s earned billions yet has seldom donated to any charitable organization. Since some readers may already donate to charities or may consider doing so in their financial future, I thought this subject would be worth discussing.

First of all, I don’t think that there’s anything wrong with charity. In fact, when done correctly, charity is a very noble act. Furthermore, I don’t buy into the libertarian argument that if billionaires such as Jobs want to help the world, then they should create another billion-dollar company. Yes, the world would be better off with another major company employing thousands. However, that suggestion is not fair to the billionaire himself. Isn’t creating a single billion-dollar fortune enough in a lifetime? Successful companies are not created with a mere snap of the fingers. More often than not, the fortunes they give their owners take decades, maybe even a lifetime or more, to amass.

The whole point of charity is not creating something personally. It’s about giving money to someone else so that they can create some good in the world. Though a theoretically sound idea, asking Bill Gates to create a second Microsoft instead of donating to charity is a fairly unrealistic suggestion. He has done enough already.

Despite the above comments, I dislike most charities and nonprofits. I acquired this perspective only after working for a few nonprofits and volunteering at others. Those experiences didn’t open my heart to the wonders of charity… rather, they opened my eyes to the wastefulness, bureaucracy, and lack of care underneath the glossy public images of most charities. For this reason, I don’t blame Steve Jobs for not donating any money. Finding a good charity is hard work, and it’s a full-time job ensuring that sizeable funds are spent well.

If one wants to dump a pile of money somewhere and feel good about themselves, that’s easy. Plenty of billionaires are doing that. Take, for example, Mark Zuckerberg’s $100 million donation to Newark public schools. Zuckerberg might as well have set the money on fire. The end result would have been the same. I’ve often read stories of public school districts (such as in New Orleans) where the district receives $11,000 per student. Despite the money, the educational results were horrible. Personally, I attended a private school at tuition of $2,500 per year and received a decent education. You do the math; one doesn’t need a Ph.D. in economics to figure this out. Zuckerberg’s donation might as well have been a cash bonfire. At least he can smile with self-gratitude in the fire’s glow.

Wastefulness doesn’t just happen in public schools. Many charities gobble funds in their bureaucracies. Often donations are used to hire pimple-faced sociology majors promoting an “awareness” campaign rather than directly helping those in need.

A few years ago, I volunteered extensively at a soup kitchen. The place had a really nice building and a huge staff. The food was donated, prepared, and served by volunteers. All the monetary donations went into a bureaucratic black hole. Everything else after building and infrastructure costs covered the payroll of numerous secretaries and office bureaucrats. I still can’t figure out exactly what they did all day – it surely wasn’t feeding the homeless.

I had the same experience in the nonprofit think-tank world. The amount of wasted money is simply astounding. Furthermore, political think tanks have minds and agendas of their own. Unless you’re one of the top ten donors, most really don’t care about your opinion. A few large players dominate an organization’s direction, and everyone else’s donations are expendable cash.

However, in my experience, one nonprofit think tank did stand out: the Ludwig von Mises Institute. I’ve been a summer fellow there and can say firsthand that these guys spend their money wisely and care about their donors. Unfortunately, discovering this fact required three months of being there. Without spending a lot of time to study an organization inside and out, one can’t know its inner workings.

The author of the New York Times article on Jobs has a very naïve view of the charity world. It’s easy for a billionaire to throw millions out the window. It’s much harder to find a place where the money will be well spent. As the piece noted, Jobs did start a foundation, but then closed it about a year later. I wouldn’t be surprised if he discovered the difficulties of properly managing a charity. I applaud him for closing the project rather than throwing money into a perpetual sinkhole. In a way, refusing to give money to any charity hustler shows more caring than throwing cash around like Zuckerberg. Money poorly spent helps no one in need.

For the rest of the issue, Doug Hornig will discuss some of the drawbacks with GLD. If you’re thinking of investing in this gold ETF, this piece is a must read.

Tracking Gold

By Doug Hornig

Recently, we’ve received a number of emails from readers asking why the primary gold ETF, SPDR Gold Trust (NYSE: GLD), doesn’t more closely track the price of gold, and other related questions. For those readers who aren’t already familiar with the workings of this innovative way to “own gold,” it’s worth going over a few of the details, because there are some common misunderstandings regarding the ETF.

The creators of GLD were as savvy as it gets. They saw a market crying for something like this and turned that need into one of the most successful new financial products ever introduced. The ETF burst upon the scene in November of 2004 and was immediately latched onto as a means of riding the gold bull market without the inconvenience of having to transport and securely store actual bullion. In the past seven years, its rise has been meteoric. It has steadily ascended the list of the world’s leading gold repositories, until today it has the sixth-largest global stash of the metal, at more than 1,230 tons, or 39.57 million ounces, worth over $70.7 billion.

First misconception: Contrary to popular opinion, the SPDR Gold Trust does not buy and sell gold. It creates and redeems paper shares in the company. These are passed through a group of market makers, who trade them on the NYSE, then deposit into or withdraw from the HSBC vault in London the corresponding amount of physical bullion, in the form of 400 oz. London Good Delivery bars.

And even that description is somewhat misleading. GLD deals only in “baskets” of 100,000 shares, with the goal being for the share price to track gold’s market value as closely as possible. Since each share represents slightly less than a tenth of an ounce of gold, that means each basket must trade close to 10,000 ounces of gold. That’d be impractical if the buying and selling had to be done on the open market.

So how do they pull it off? Well, the company is not exactly forthcoming about its inner workings, but after extensive conversations with officials, I was able to determine that what actually happens is that the gold is moved either into or out of the GLD-allocated section of HSBC’s vault, to or from another section of that same vault. When I found that out, I envisioned a guy on a yellow forklift, driving pallets laden with thousands of ounces of gold back and forth across the vault floor. Such a job.

Beyond the basics, we don’t know much. You will not be allowed to see the vault, whether or not you are a GLD shareholder and no matter how many shares you own. In fact, a high Trust official in New York told me that even he isn’t allowed inside there.

For the most part, GLD does a pretty good job of following the spot price of gold. A share will never be priced exactly at the value of a tenth of an ounce of metal, simply because the Trust deducts transaction fees and other expenses. But it’s close. During August of 2011, for example, the net asset value (NAV) of a share of GLD varied from 97.3635-97.3867% of the gold price, as fixed each day at 10:30 a.m. New York time.

However, if you are an investor in GLD, or are considering becoming one, there are a few things to keep in mind. First of all, it can’t be stressed enough that this is a paper asset. It is not a way to buy gold and have someone else store your holdings for you. That can be done in other ways. There are depositories that specialize in this service, both domestically and in foreign jurisdictions like Switzerland. But that isn’t what GLD is about.

Now theoretically, it is true that you can convert your GLD shares to physical gold and take delivery of it. But practically, you can’t. For one thing, you have to be approved to do so (generally meaning, you’re either a broker or a market maker), and then you have to redeem a minimum of 100,000 shares. And even if you meet those qualifications, buried in the firm’s prospectus – a very tough read, by the way, but you can get a copy at their website if you want to try your luck – is a provision stating that they have the option of redeeming such shares in cash equivalent rather than bullion.

This is to say: If there is a sudden run on physical gold, GLD is not contractually obligated to provide actual metal, in exchange for however many shares, to anyone.

Thus our position has always been: Hold as much gold in coins and bullion as you comfortably can. Use the ETFs to generate profits if you like, but make sure you realize that all of those profits will be of the paper variety.

Furthermore, there is the little matter of taxation. You may well understand that GLD shares are not a substitute for precious metals, and you may be in it only as a way to make money from a rising gold price by simply placing an order with your regular stock broker. If so, well and good. But what you may not know is that GLD shares, although they trade like stock, are not stocks in the same sense as Apple shares. Not when the taxman cometh.

If you buy shares of Apple, and hold them long term, for more than a year, then sell them, you are taxed at the prevailing capital gains rate, currently 15%. Gold, however, is considered a “collectible.” If you buy gold coins, for example, and hold them long term, then sell them, your tax liability is at the rate for collectibles, presently 28%. If you sell them for a short-term profit, you’re liable for taxes at the same rate as for ordinary income, which is determined by whatever bracket you’re in.

Of course, GLD shares are not gold, as I’ve just taken some pains to point out. Ah, but here’s the rub. GLD is structured as a grantor trust, not a mutual fund. A grantor trust is ignored for tax purposes so that the investor is treated as owning a pro-rata share of the underlying holdings, not the entity as it exists on paper. That is to say, if GLD were a mutual fund, shares would be taxed at the normal capital gains rate, but because it is a grantor trust, its long-term gains are taxed at the applicable rate for the gold it holds… which is 28%.

This situation leads to some rather odd tax peculiarities. Say your ordinary income is in the 25% tax bracket. You’re actually better off selling GLD shares short term than you would be if you held them long term and got pushed into a 28% liability.

None of this is to disparage GLD. For ordinary investors, the ETF represents a way to (indirectly) participate in gold “ownership” without the hassle of actually taking physical delivery and finding a suitable place to vault your metal. Plus, there are no storage fees, bid/ask spreads, threats of theft, or dealer markups to worry about. And finally, for those who like to really play the market, shares are amenable to all the tricks of the securities trade. They can be optioned, shorted, hedged, bundled, margined, whatever. Little wonder GLD is so wildly popular.

So use GLD if you are of a mind to. Just be certain you understand what it is you are dealing with.

[Other ways of indirectly investing in gold exist; some offer even more upside potential than the metal itself. Learn what they are and how to make use of them with a subscription to BIG GOLD. It’s risk-free for three months.]

Additional Links and Reads

Gold’s “Absurd” Price Makes Stocks Look Cheap (Bloomberg)

In my opinion, this sort of chart is a great example of misleading analysis. It shows the spread between the SPDR gold ETF and the SPDR Dow Jones Industrial average ETF. Clearly, gold has increased a great deal on this chart. Hence, the analyst from Mirae Assets claims that gold has reached an “absurd” level.

Okay, the line on his chart has gone up. So what? Is there a causal relationship between the DJIA and gold prices? If the chart showed the price of gold increasing with the money supply falling, then there might be a point to be made. Gold has a relationship with that measure.

However, creating a chart where a strong relationship doesn’t exist is pointless. Is there a “correct” gold-to-DJIA ratio? I could similarly create a chart of the spread between tomatoes and gold. The yellow stuff would be going off the chart in comparison to tomatoes. Does this make gold absurdly overpriced? I don’t think so. Furthermore, consider gold’s behavior lately as a flight to safety. As the market has fallen, gold has increased in price. As a result, the spread between the two has widened. The same is true for any flight to safety when compared to the DJIA.

China Bans Gaga and the Backstreet Boys (CNN Marquee Blog)

Sometimes, investors can get too ahead of themselves with China. Sure, it’s a rapidly expanding country with some good ideas, but don’t forget that China still does plenty of stupid things... such as banning Lady Gaga, Katy Perry, and the Backstreet Boys. Now, I do sympathize with the Chinese government’s taste in music. Perhaps if I were dictator, Lady Gaga and Katy Perry would be banned as well.

But regardless of my personal taste, this is a huge waste of time. Furthermore, this action might even hurt the Chinese economy. Haven’t you seen those empty shopping malls in China? First, one has to dumb down and brainwash the kids into an Abercrombie & Fitch and MTV culture. Then the malls get filled. It’s been working in America for ages. China still has a lot to learn about capitalism.

That’s it for today. Thank you for reading and subscribing to Casey Daily Dispatch.

Vedran Vuk
Casey Daily Dispatch Editor