What are Gold ETF Funds?
Investing in gold or other precious metals is very popular these days, but precious metals investing requires special attention to the logistics of the purchase. Gold ETF funds provide a method for investing in gold that eliminates these issues. The logistics referred to are the problems of insurance, storage, moving, and reselling, along with many others. Here we will clarify what ETF gold funds are, and some of the better ways to trade them.
Firstly however, you should understand what the term ETF means. An ETF is an Exchange Traded Fund, meaning it is traded on the major stock exchanges. The NYSE, and NASDAQ have ETF’s, but the American Stock Exchange (AMEX) is the primary trading venue for Gold ETF funds. When you buy an ETF, you are typically investing in a conglomerate of companies, rather than a single corporation.
It works like this, the Gold ETF fund will purchase a large amount of gold, maintaining the physical metal in storage. They will then issue shares in baskets, the idea here being that the value of the shares will increase with the price of gold bullion. If the price of gold goes up by 10%, then individual shares would increase in value by the same 10%.
What makes this attractive to most buyers is the fact that trading in gold can be done very easily at any time during stock market hours using your online brokerage account. Another thing people like is you don’t have to buy a large amount of gold to invest. Most gold ETF funds have a minimum investment but you can buy in portions of an ounce. This is really ideal since the price of an ounce of gold these days is not something everyone can afford to purchase.
Some of the more popular venues for buying gold or gold mining companies include the SPDR Gold Trust (GLD), Market Vectors Gold Miners ETF (GDX), and ProShares Ultra Gold (UGL). Here’s a brief explanation of how these funds work:
SPDR Gold Trust (GLD) was the very first Gold ETF fund and still the most popular. They purchase 400 ounce gold bars from London Good Delivery Bars, and issue the shares at one tenth of the price of an ounce of the gold.
ProShares Ultra Gold (UGL) is for the seasoned investor who is very aggressive and not averse to risk. Also known as a double gold ETF, it is designed to double the investment return, in other words, if the price of gold increases by 10% the value of the shares should increase by 20%.
Market Vectors Gold Miners fund (GDX) attempts to mirror the NYSE Arca Gold Miners Index as closely as possible, before any fees are removed from the investment. Using index investing, your portfolio will have 32 mining companies behind it. Keep in mind, this type of Gold ETF is made of up gold company stocks, thus it tracks the gold stock index, not the gold price index.
This should provide a good basic overview of Gold ETF funds and how they can be used to invest in precious metals while avoiding excessive fees and unnecessary risk.
Gold ETF – Canada
If you’re looking for a purely Canadian Gold ETF, Canada has one you may wish to consider; Central Gold Trust (GTU on the New York Stock Exchange or GTU.U on the Toronto Stock Exchange, TSX.) Though technically a closed end fund (CEF), it trades on the stock market just like an ETF and the big advantage to the Central Gold Trust is that it’s a pure gold play, meaning its primary holding is gold. As of the beginning of 2010 GTU’s assets consisted of 97% gold bullion, 1.5% gold certificates, and 1.5% cash for basic working capital. While this seems like it should be obvious many named gold funds actually trade through many other precious metals or simply hold large quantities of cash. The gold in the name is used to attract less sophisticated investors.
While some gold funds may be able to perform better, it is more difficult to determine how the fund intends on making money without understanding the fund manager who is employed at the time. Even if like the prospects of a fund manager they will change over time. When you invest in GTU you are truly investing in gold.
Is the Price Worth it?
Currently the price of GTU is about 8 times earnings. Normally I don’t like to buy any stock that has a price to earnings greater than what I perceive its annual growth to be. If you believe that gold will grow greater than 8% per year over the next couple of years then this could be a great buy. However, this Canadian gold ETF is so purely a gold purchase that I would have to factor in the main purpose of buying gold is as an inflation hedge and diversification from a all corporate equities portfolio. So even if gold only grows 4% per year giving you a PEG (price / (earnings * growth)) of around 2.0 this is still a good buy to balance a portion of your retirement account.
Why a Canadian Stock ETF Versus Real Gold?
There are two main reasons I prefer a gold exchange traded fund to buying actual gold:
Liquidity – The reason you invest is to convert your investments into goods in the future. Sometimes a trip to Hawaii is just nicer than a hunk of metal. When you purchase gold and keep it yourself you have to find a broker to convert the gold back into cash. This involves an appraisal, shipping, driving, phone calls, or other general nuisances getting between you and your money. An ETF is traded over a major stock exchange through your normal stock broker. A sell order will be transacted in moments with your cash virtually instantly available.
Reasonable Spread – The spread is the most ignored fee in investing. The spread is the difference between what the market makers are selling an equity for versus what they are buying them for. The spread on stocks is about 1% of the purchase price. This means the gold ETF needs to earn 1% before you earn a penny. Owning gold has a carrying cost of around 7%. If you don’t plan on holding gold for a length of time this 6% difference can bite into your earnings.
Gold ETF – India
When looking to international markets for a gold ETF, India would often be first on your list. Why is that? Simply, India has probably the largest fascination with gold than any other country in the world and is by far the world’s largest buyer of gold, accounting for 9.5 percent of the world’s total gold holdings. More impressive is the fact that current demand from India alone consumes 25% of the world’s annual gold output.
Gold is viewed in India as a symbol of power and wealth. However more so nowadays, the people of India buy gold as a hedge of protection from their own rupee currency and government mismanagement. Gold is highly valued so much so that it’s not uncommon for an Indian to use their gold jewelry as collateral for a loan.
It’s no wonder then why India is often associated with gold and why investors would expect a gold ETF in India to be an investment worth considering. Fortunately India doesn’t disappoint as there are currently 6 gold ETFs India has to offer, all of which are traded on the National Stock exchange (NSE).
Now before I get into the specifics of these ETFs, I should mention that if you are a US investor and wish to buy a gold ETF for gold exposure, there’s really no compelling reason to own an Indian gold ETF over an American one unless of course you believe the Indian rupee will continue to devaluate at its current pace which has made Indian gold ETFs quite attractive over the past few years. Long term however, I would personally stick with the most popular ETF gold fund; the SPDR Gold Trust (NYSE:GLD). The GLD has a very large trading volume making it liquid enough for most investors coupled with a low expense ratio (0.6%). Indian gold ETFs on the other hand have typically higher expense ratios ranging from 1% up to 2.5%! Not to say Indian ETF funds are a bad choice; they just wouldn’t necessarily by the first choice for someone living in the US. If you happen to live in India however, they are definitely worth considering as an alternative to owning physical gold.
Here are the 6 gold ETFs available in India:
- SBI Gold ETF (SBIGETS.NS) – The State Bank of India’s gold ETF is the newest addition to India’s market.
- Gold Benchmark ETF (GOLDBEES.NS) – The most popular and considered by many as the best gold ETF in India.
- UTI Gold ETF (GOLDSHARE.NS)
- Kotak Gold ETF (KOTAKGOLD.NS)
- Reliance Gold ETF (RELGOLD.NS)
- Quantum Gold ETF (QGOLDHALF.NS)
A Short Gold ETF For the Bears
For some gold bugs it’s hard to imagine buying a short gold ETF, especially with such a strong gold market these past few years. Though it’s difficult right now to see a need for an inverse gold ETF, remember not that long ago gold was not a strong performer to say the least.
Now I’m not saying that gold is about to take a nose dive into bear market territory but it has been on a tear lately and could be due for a correction of some kind. You know the saying, “what goes up must come down”. Well that’s not always true in the investing world but like all common sayings there is “some” truth to it. No investment goes up all the time and though it seems the gold price is trending up long term, it still can come down a number of times as it corrects in price from over exuberance in the gold market. It is at these times where short gold ETF funds can be become a profitable tool so long as they’re utilized correctly, which comes with experience and technical analysis skills.
Gold is money and because the fiat currencies are being devalued, in particular the USD, gold continues to gain value as a hedge against the risk of government mismanagement and over spending. Gold has and always will have value and during times of uncertainty, investors and people in general, snatch up what they consider to have value, especially gold. This is one of the reasons why gold has been doing so well lately. All the turmoil, uncertainty and fear throughout the global markets has served as the primary catalyst for gold’s rapid rise in value.
Having said all this, eventually after all this turmoil is behind us, gold will begin to level off over the long term and may even decline just as rapidly as it had gained. Gold will always hold value but it’s a commodity like anything else and at the end of the day its value is determined by supply and demand. So if gold starts its decline, you’ll want to take advantage of this, just as you hopefully did on its way up. The best way to profit from a decline in gold is to buy an inverse gold ETF or ETN. Since they are exchange traded funds they can easily be bought and sold freely on the stock market making them ideal for both trading and holding long term.
The following is a list of the most commonly traded short gold ETFs on the major stock markets:
Short Gold ETF (GB: SBUL) – Traded on the (LSE) London Stock Exchange the SBUL short gold ETF trades inversely to the current gold price.
DB Gold Short ETN (DGZ) – The DGZ is an ETN traded on the NYSE that is also priced inversely to the gold price so if gold goes down 1%, DGZ will go up 1%.
DB Gold Double Short ETN (DZZ) – Similar to the DGZ, except that it is leveraged 100%, and thus trades at double the inverse of gold. This gold short ETN can be thus be very profitable if you’re on the right side of the trade.
ProShares UltraShort Gold ETF (GLL) - This double short gold ETF also trades at twice the inverse of current gold prices, only it is an ETF (vs. ETN).
Leveraging With a Double Gold ETF
A double gold ETF is a leveraged ETF that moves up and down with the price of gold, only doubly so. In other words, if the price of gold goes up 10%, a double gold ETF will go up 20%. Conversely if the price of gold drops 10%, a 2x gold ETF will drop 20% in value.
The attraction for these types of leveraged gold ETFs especially the double long gold ETF has been increasing over the past few years as investors have watched the gold price skyrocket. If you are convinced that the price of gold’s general direction is going to be upward, why not be doubly rewarded as it climbs? Well unfortunately, like most things it’s not really all that cut and dry. Yes, you can drastically increase your yield by investing in a double gold ETF but if you are wrong, even in the short-term, do you have the fortitude to watch the price of gold tumble along with your invested funds? The gold price may come back again and even surpass your projected price, but if you do not have enough conviction of this, you may end up selling for a big loss.
Thus, due to the already extremely volatile nature of the price of gold, gold double ETFs should only be reserved for the most seasoned investor who is not averse to risk and is only risking a small portion of their overall investment portfolio.
Having said that, a lot of investors have been handsomely rewarded for being invested in a double gold fund these past few years and many gold bugs would argue that gold still has a ways to go before it begins to cool off.
If you are one of those investors whose willing to take on the extra risk, you can either invest in a gold ETF or gold ETN. A gold ETN (exchange traded note) is similar to an ETF except that investors hold the debt security until it matures, at which point the issuer will give you the principal amount. Essentially ETN’s have the properties of both an ETF and a bond.
Here are the four main double gold ETF & ETNs to buy:
PowerShares DB Gold Double Long ETN (DGP) will move at the double the gold price and is meant for long gold investments.
PowerShares DB Gold Double Short ETN (DZZ) is the exact opposite of DGP in that it will move at double the price of gold yet in the opposite direction. So if you think gold is going to drop, it’s a perfect investment vehicle for short gold plays.
ProShares Ultra Gold (UGL) ETF will move at double the price of gold and is meant for investors who are long on the gold price.
ProShares Ultra Short Gold (GLL) ETF moves at double the price of gold in the opposite direction, thus ideal for those short on gold.
Best Gold ETF to Buy
So what is the best gold ETF to buy that will yield the highest returns possible in a gold bull market? Do I have a personal favorite ETF gold fund? Yes actually I do, but before I get too far into which ETF I think is best overall, it’s important to distinguish first what is meant by a Gold ETF as some investors interpret this differently than others. Essentially there are two different types of Gold ETFs, one is an exchange traded fund that tracks the price of gold, with each share worth 10% of the gold price. If referring to this type of ETF, I like the SPDR Gold Trust ETF (GLD), mainly because it has the highest average daily volume, and thus greater overall liquidity which allows me to trade the stock much more easily on the market.
The other type of Gold ETF, which is the one I want to focus on for this post is an ETF that contains gold stocks and securities sometimes known as a Gold Stocks ETF. This type of ETF is obviously very different than one that simply tracks the price of gold. As such, a gold stocks ETF though influenced by the price of gold, will not directly follow it since you are investing in gold companies and not the price of gold.
So what is the best ETF to buy in terms of those compiled of stocks? Well, I’m going to cheat here and say that I like two; one that trades on the Canadian market and the other on the US Market. The Canadian gold ETF I like is iShares CDN Gold Sector Index (XGD.TO). Traded on the TSX (Toronto Stock Exchange) this gold stocks ETF contains some of the best gold and mining companies in the world including large cap names such as Barrick Gold, Goldcorp, Newmont Mining, Anglogold, Kinross gold, and gold fields. It also contains some very high growth small cap gold stocks including Aurizon Mines, and Red Back Mining. Also, with this ETF being priced in Canadian dollars, some might argue you are better protected from a weakening US dollar. In actuality though, it’s really more of a convenience factor. If you have a Canadian brokerage account, you more than likely want to keep your funds in Canadian currency, particularly for an RRSP account.
The other Gold ETF to buy on the US market is the Market Vectors Gold Miners ETF (NYSE: GDX). Traded on the New York Stock exchange, it is a very similar exchange traded fund to XGD but actually contains 30 holdings compared to the XGD’s 19, so you actually get a broader exposure to the precious metals sector.
Remember though, you don’t have to buy what I like, in fact it doesn’t really matter in the end which particular ETF gold fund you choose so as long as it has sufficient exposure to the gold sector, has had good past performance (meets or exceeds the gold index), and has a relatively low management expense ratio (MER).
Gold Bullion ETF vs. Physical Gold Bullion
Many investors buy a gold bullion ETF to capitalize on gold’s price movements. So what is a gold ETF vs. bullion and how does buying an ETF differ from actually buying physical gold?
A gold bullion ETF is simply an exchange traded fund that tracks the price of physical gold. If the price of gold goes up 10%, the ETF will go up the same proportion and if the gold price goes down 10%, again the ETF will follow. Each ETF share normally represents one-tenth of an ounce of gold bullion.
Now before deciding to buy a physical gold ETF, there are a few things you should know about them. Firstly, like all ETFs there is a MER (management expense ratio) involved to cover the costs of managing the fund. Luckily however the fee is typically very low (~0.4%) compared to other types of funds.
Another key point about an ETF gold bullion share is that unlike buying physical gold coins or bars, you don’t actually own physical gold by owning a gold ETF share. Yes, you own shares in gold, but not the gold itself. Is that a problem? Well yes and no. It’s not a problem at all if all you’re wanting to do is profit from price movements in gold. In fact buying a physical gold ETF is perfect for capitalizing on gold price movements since like all ETFs, it’s simply a stock traded on a major stock exchange which can be bought and sold easily. However, if you’re primary reason for buying gold is to hedge yourself from a large wide-scale monetary crises, you would be wise to consider buying physical gold bullion rather than the ETF, or at least in addition to it.
The reason I say this is because if there was a large scale monetary crises in the US, let alone worldwide, it’s very possible the banking institutions that are controlling these Gold Bullion ETFs could become bankrupt or insolvent. As a result they would likely end up liquidating the ETF and you would end up with no gold bullion any very little cash for your shares, if any.
Now I’m not saying this is likely to happen, but if you’re a gold bug, you have to consider why you are wanting to own gold and I’m sure one of the main reasons is to hedge your risk from fiat currencies.
So now that you understand the distinction between owning gold bullion and owning a gold ETF, here are the main gold bullion ETFs available on the market:
StreetTRACKS SPDR Gold Trust (NYSE: GLD) – By far the most liquid gold ETF available on the US market.
iShares COMEX Gold Trust (NYSE: IAU) – Another good alternative gold ETF investment vehicle.
ETFS Physical Swiss Gold Shares (NYSE: SGOL) – A newly launched (Sept, 2009) gold ETF that distinguishes itself from the others by holding it’s physical gold in Switzerland.
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