"QE to Infinity and Beyond," says Mike Shedlock! - Word of the Day: Exchange-Traded Fund (ETF)

Welcome to Capital Account. Today we talk about "foot-in-mouth" disease, given Mitt Romney's recently exposed comments stating that 47 percent of voters "believe they are victims" and are dependent on the government. It seems the "foot-in-mouth" indicator is as important as the economy in this Presidential election. Even though this appears to be a bearish indicator for Mitt Romney, we ask our guest, Mike Shedlock, if there is a bullish case for the economy when it comes to either the Republican or Democratic Presidential candidate. And what is the true state of the economy? We talk to Mike Shedlock, Investment Advisor for Sitka Pacific Capital, about indications that the US is in recession. Also, Mike Shedlock, author of the blog Mish's Global Economic Analysis, tells us about his top ten list of the most dangerous politicians in Europe. Plus, according to a report posted on the NASDAQ's website, investors plowed more than 15 billion dollars into ETFs last week in anticipation of QE3. What exactly is an Exchange Traded Fund, and more importantly, what is in the fine print? We break it down in Word of the Day. Also, GE's medical imaging healthcare business is slowing down, but is this partly because of changes GE made to the health plans of its own workers? Lauren and Demetri talk about it in today's Loose Change. Word of the Day: Exchange-Traded Fund (ETF) Time now for Word of the Day where we break down a financial term for our smart viewer but maybe not the financial expert. Today it's ETF or Exchange-Traded Fund. By attracting those looking to invest in nontraditional assets and sectors, the global ETF market has inflated to more than a trillion dollars in assets over the past few years...some put that number now at about 2 trillion dollars. David Kotok wrote a book on ETFs and spoke about them on our show recently. However, Kotok warns that investors should conduct serious research before purchasing shares in an ETF. We'll explain why shortly, but first, what exactly is an Exchange-Traded Fund (ETF)? Here's our definition: ETFs are a portfolio or basket of securities, which provide diversification like mutual funds, yet are unique in that they trade on an exchange just like a common company stock. They usually track an index, either holding the underlying stocks of the index or using derivatives to achieve the same returns as the index. And since an ETF is designed to track a specific market index, one can play an entire sector without being forced to stomach the volatility inherent in any one stock. For instance, investors can gain exposure to precious metals using ETFs. Specifically, Gold and gold miner ETFs have become increasingly popular. But if you buy shares in a gold ETF like the GLD for example, the largest gold ETF in the world, do you actually own gold? The answer is NO. You are effectively buying shares in a fund indexed to the gold market. This is not the same thing as buying physical gold bullion and storing it in allocated vaults, a key distinction. In fact, according to the ETF's own prospectus, the average investor can only redeem his or her gold shares for cash. Only those who have large holdings in a fund like GLD have the option to redeem their shares for physical gold, requiring somewhere in the neighborhood of 100,000 shares, which translates into millions of dollars. And even then it's a complicated process. Also, in the case of GLD, the Trust does not insure its gold. Which means it may not have adequate sources of recovery if its gold is lost, damaged, stolen or destroyed. And this may surprise you when reading the prospectus as we have. According the prospectus for GLD: "The amount of gold represented by the Shares will continue to be reduced during the life of the Trust due to the sales of gold necessary to pay the Trust's expenses irrespective of whether the trading price of the Shares rises or falls in response to changes in the price of gold." And... "Gold held in the Trust's unallocated gold account and any Authorized Participant's unallocated gold account will not be segregated from the Custodian's assets. If the Custodian becomes insolvent, its assets may not be adequate to satisfy a claim by the Trust or any Authorized Participant." So if the custodian- in this case HSBC- runs into trouble, it may not be able to make good on your claim. So it would appear the only way to protect yourself as an investor when it comes to ETFs is to do detailed research on the fund, its assets, and carefully read its prospectus, and even then you are still dealing with counterparty risk. This is why some would argue that buying a gold liability, which is what a gold ETF is, defeats the purpose of owning gold in the first place, as precious metals are one of the few asset classes accessible to average investors that are not simultaneously another person's liability. In any case, now you know about ETFs and if you're interested, you know to get your reading glasses ready to dissect the fine print.