Gold ETF

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.