Risks Assosicated With Gold Exchange Traded Funds & The Benefits of Direct Ownership (physical gold)

   Gold ETF's are index traded commodity funds with a total net worth that's tied to the value of its holdings of physical gold (for example SPDR's (ETF) market value on August 26 was $75.07B about the same as the total value of its 39.6M ounces of gold). The physical gold is stored in vaults/warehouses operated either by groups of institutions (London Precious Metals Clearing Limited made up of six entities) or individual ones that have been granted a vault license (as in the case with JP Morgan). Shares are issued, giving individual private investors exposure to commodity price movements. In general, ETF's have low tax costs in addition to other cost efficiencies, making them increasingly popular among investors. The first successful ETF ever launched was the Toronto Index Participation Shares (tracked the TSX exchange's 35 biggest stocks) which began trading in 1990.

Gold exchange-traded funds trade on stock exchanges like any other fund however their portfolio consists of only one asset, physical gold. Two of the most actively traded American ones are IShares COMEX Gold Trust (IAU, large cap) and SPDR Gold Trust (GLD, one of the largest in the world, started in 2004). Jewelry is also an important source of the physical gold supply, in 2007 it accounted for 25% of total supply. In terms of bullion, Kruggerands issued since 1967 and gold bars (some vaults require the stored bars to be a specific size, usually between 350 and 400 ounces) have traditionally been the most widely used. Alternatively, gold mutual funds aren't as dependent on physical gold; Their asset types include a range of gold stocks/companies (gold companies, for the most part have wide profit margins, making them attractive to all types of investors).

In many cases Gold ETF's have management and accountability issues. Since their early beginnings, there has been substantial growth in the size of Gold ETF's (10 largest American ones hold about 2,200 tons (2,000 tonnes/70.4M ounces) of pure gold in the form of bullion bars, other countries like China have launched their own gold trading platforms). (China's Gold Intake:like Sending Oil to Saudis) making the accountability issue an even greater concern. There is also growing angst over just how much gold is actually in the world's vaults; in March 2008 90 kg of fake gold was discovered in the vaults of Ethiopia's National Bank (replaced with gold plated steel), that happened even though gold sold to the central bank is required to undergo certification by the Geological Survey. (BBC News: Fake fears over Ethiopia's gold) In Europe, gold plated Tungsten was found at Germany's largest private gold refinery, though alarming that doesn't necessarily mean the government certified any of it.

There's also risk in the US where SPDR, the world's biggest physically-backed gold trust states in its list of risk factors:
"Because neither the Trustee nor the Custodian oversees or monitors the activities of subcustodians who may temporarily hold the Trust’s gold bars until transported to the Custodian’s London vault, failure by the subcustodians to exercise due care in the safekeeping of the Trust’s gold bars could result in a loss to the Trust." and "Gold bars allocated to the Trust in connection with the creation of a Basket may not meet the London Good Delivery Standards and, if a Basket is issued against such gold, the Trust may suffer a loss."

Owning physical gold eliminates those risks, removing concerns regarding delivery of the asset however the new costs makes it much more expensive to do especially if you're in it as a short term investor (dealer fees can range from a couple dollars to more than ten dollars an ounce over spot, ensuring secure storage of the physical asset is costly as well as time consuming).

Countries are taking more interest in gold; 10% of all foreign exchange reserves are in gold. (World Gold Council) South Korea purchased 25 tonnes of gold in the summer of 2011 for $1.24 billion, making its total reserves 17 times larger (39.4 tonnes) and ranking 45th among all countries. In 2011 Russia (41.8 tonnes), Thailand (9.3 tonnes) and Mexico (99.2 tonnes) also increased their reserves of gold. China's massive holdings only equal about 1.6% of their currency reserves. (S Korea buys gold as safe haven, first time since '98)

Because the prices of gold ETF's is more closely linked to the price of gold than other investment options (individual mining companies, mutual funds), risk also comes from spot price volatility (some companies actually hedge against that by fixing the price at which they agree to sell their gold in the near future). There is also slightly more risk than with mutual funds because like stocks, ETF's trade all day long (like their underlying commodities which also vary in price throughout the day, for mutual funds trading in the underlying stocks ends at the conclusion of the trading day and so they do as well).

Some other notes:
-If any widely used currency ever failed a new gold standard could be implemented as a temporary fix until the situation is resolved.
-Tungsten has nearly the same density as gold but differs in its color and hardness. Thermal conduction of gold (atomic number 79) is about two times that of tungsten (atomic number 74), the ratio of boiling points is also two.