Michael Burry rose to fame after his bet against mortgage bonds in the run-up to the 2008-09 global financial crisis was chronicled in the book he wrote, "The Big Short," as well as the movie of the same name.
So it is interesting to note that his Scion Asset Management dumped positions in Alphabet (GOOG) and Amazon.com (AMZN) during the first quarter, while buying shares of an ETF that invests in physical gold, according to a recent filing with the SEC. The ETF is the Sprott Physical Gold Trust (PHYS).
It’s easy to see why Burry bought gold (GCM24). There are a number of factors behind its recent rise to record highs. Among those reasons are the following…
Why Buy Gold?
Central banks have been buying about 400 tons a year of gold since 2010 or so. But in 2021 and 2022, they bought twice as much! And last year, the buying was still at about 750 tons.
What changed? Geopolitics. While the U.S. dollar ($DXY) remains the dominant currency in both global trade and global currency reserves, “China block” countries have increased their holdings of gold from near-zero to about 7% of total reserves.
It looks like official buying of gold by China slowed in April, as prices hit new record highs. Whether the Chinese government continues to add to its gold reserves at current prices remains to be seen.
But one thing is certain; the appetite for gold from the mainland's wealthy individuals seems to remain quite healthy. Individual Chinese investors are looking for a safe haven, thanks to the ongoing rocky period for both the country's real estate and stock markets. In China, there is even a new trend among the young to buy tiny 24 carat “beans” every month as a form of long-term saving, as stocks and the property market fade.
Perhaps gold investors are anticipating a specific inflationary scenario — financial repression, in which inflation runs hot, but central banks like the Fed keep rates artificially low, for fear that sovereign debt burdens will become unbearable. At the same time, more countries may defect from the dollar-based world order, holding more and more of their reserves in gold.
And then we have the world’s wealthy. Family offices and asset managers that cater to the rich are increasing gold’s allocation within their portfolios to the 10%-15% range, up from a historical allocation around 5% to 7%.
There are several exchange traded funds (ETFs) out there that are backed by physical gold. The largest and best-known of these is the SPDR Gold Shares (GLD).
However, it is interesting to note that Burry instead purchased shares of PHYS. There are several very good reasons why he did, and why you should also consider this ETF because it is superior to GLD. Let me highlight some of those reasons for you.
Holding Onto Your Physical Gold
If you are like many gold investors, and want to hold physical gold and not “paper” gold - PHYS is for you.
That’s easy to see if you look at the objectives of each fund in their prospectus, where the difference between the two becomes apparent. For GLD, the objective is: “to reflect the performance of the price of gold bullion, less the expenses of the Trust's operations.”
For PHYS the objective is as follows: “The Trust seeks to provide a secure, convenient and exchange-traded investment alternative for investors interested in holding physical gold bullion without the inconvenience that is typical of a direct investment in physical gold bullion.”
Also, shareholders of the Sprott Physical Gold Trust have the right to redeem their shares for gold bullion. GLD owners do not.
Next, we come to the sticky question of who is actually holding that gold bullion.
The SPDR Gold Shares ETF's gold may be held with sub-custodians, which are chosen by the custodian - HSBC Holdings (HSBC). Those sub-custodians may use additional sub-custodians to hold GLD's gold. If gold held by a sub-custodian is lost or stolen, GLD shareholders have limited legal options to recoup the bullion.
The custodian for the 400 ounce gold bars of the Sprott Physical Gold Trust is the Royal Canadian Mint. The Mint is a Canadian Crown corporation, which acts as an agent of the Canadian Government, and its obligations generally constitute unconditional obligations of the Canadian Government. The Mint is responsible for and bears all risk of the loss of, and damage to, the Trust’s physical gold bullion that is in the Mint’s custody.
Now, it is unlikely that a sub-custodian will abscond with GLD's assets. However, in a stressed market environment, the simplicity of PHYS's custodial situation vs. that of GLD will allow you to sleep at night.
PHYS vs. GLD at Tax Time
Finally, we come to taxation. PHYS lets you own physical gold in a convenient and secure way that has potentially favorable tax advantages for U.S. non-corporate investors, versus owning the gold directly, or through ETFs.
The IRS considers precious metals to be collectibles, just like art or rare books. If you hold gold for more than one year, the capital gains tax on your net gain from selling is 28%. That's considerably higher than the tax rate on most net capital gains, which is an average of 15% for most taxpayers, according to the IRS. Of course, if you sell a collectible in less than one year, the proceeds will be taxed as ordinary income.
Special federal income tax rules apply to holders of the Sprott Physical Gold Trust, because it is classified as a Passive Foreign Investment Corporation (PFIC) by the IRS.
If a U.S. non-corporate holder makes a timely QEF (Qualified Electing Fund) election each year by filing IRS Form 8621 with their federal income tax return, it will mitigate the otherwise adverse federal income tax consequences of owning precious metals via coins, bullion, or ETFs. Capital gains will be taxed at either 15% or 20%, depending on your income level.
Conversely, GLD's gold is treated as a "collectible," and gains on holding GLD are taxable at 28%.
Buy PHYS
The only real advantage GLD has is that it is much more liquid (easily tradable) than PHYS, based on average daily share volume. That may be of greater interest to traders, not investors.
Add it all up and it’s easy to see why Michael Burry bought PHYS. It’s a buy on any small weakness in gold prices, currently around $2,425 an ounce. PHYS is trading at $18.81.
On the date of publication, Tony Daltorio did not have (either directly or indirectly) positions in any of the securities mentioned in this article. All information and data in this article is solely for informational purposes. For more information please view the Barchart Disclosure Policy here.
