USING EXCHANGE TRADED PRODUCTS TO GET EXPOSURE TO GOLD
Gold has made a strong run towards record highs as sticky inflation and concerns over a hard landing in the economy have driven investors to seek the comparative safety of the world’s favourite safe haven asset. Gold is currently trading above US$2 000 per ounce, almost doubling in value over the past five years. With the increase in demand for the metal we have certainly noticed gold coming up more often in our discussions with advisors and their clients. In this research note we look at how an investor can get exposure to gold by investing in an exchange traded product.
Investors seeking to gain gold exposure have many options, such as physical gold bullion & coins, gold futures, investing in gold mining companies or into gold funds/ETFs. Physical gold can be difficult to source, costly to trade and store, especially in larger quantities. Gold futures have counter party risk, greater volatility, and have an expiry date. Gold funds/ETFs offer investors a better alternative to access the gold market and that segment of the exchange traded universe is diverse giving investors many different choices to make. From funds continuously tracking the price of gold, to funds covering the global gold mining industry, gold ETFs have amassed significant assets and have become popular instruments for investors and traders alike.
ETFS HOLDING PHYSICAL BULLION
Exchange traded funds are wrappers for a basket of investments, which can be into physical gold. Gold ETFs which have physical gold backing are the most popular option for investors, with SPDR Gold Trust (“GLD”) being the 18th largest ETF globally enjoying over $61bn AUM with an expense ratio of 0.40%. Gold backed ETFs are structured in trusts. When you buy GLD shares, you’re buying an ownership interest in a trust, and the sole asset of that trust is physical allocated gold bullion bars. The individual investor does not own the gold that backs the trust, any more than an investor in Tesla owns a car or an investor in Netflix owns a movie.
What the investor in SPDR Gold Trust owns is an asset that tracks movements in the gold price, minus the exceedingly small costs of administering the trust. For many investors, buying SPDR Gold Trust shares is the most cost-effective method of gaining exposure to the gold price. If you are buying gold to protect your assets in the extreme crises as mentioned above, the location of the gold storage is crucially important. SPDR Gold Trust’s gold is vaulted in London and constitutes one of the largest gold hoards in the world.
The great news for investors is that the fee war that has taken place in the ETF universe has resulted in some exciting new ETFs that also provide exposure to physical gold. Both SPDR and iShares launched smaller versions of their large Gold Trusts where the expense ratio is a lot lower at 0.10% and 0.09% respectively. These smaller versions are slightly less liquid so might not be appropriate for someone looking to trade in and out of a position frequently, so are more suited to a buy-and-hold strategy.
The four largest trust ETFs that hold physical gold differ mostly in their expense ratio and vaulting, with little else differentiating them. After all, gold in South Africa is the same as gold in London.
ETFS HOLDING A BASKET OF GOLD MINING COMPANIES
Gold mining ETFs hold a basket of the shares of the world’s largest gold miners such as Newmont, Barrick and Anglogold to name a few. Weightings to each share are generally determined by market capitalisation resulting in higher exposure to the larger, and more successful gold mining companies.
The VanEck Vectors Gold Miners ETF (“GDX”) is the largest offering with an AUM of just under $15bn and is one of the more popular funds in the global gold mining segment, with exposure to a market-cap-weighted index of global gold mining firms. The correlation between the gold miners and the price of gold is quite high over the long term. However, it is not unusual to see the two diverge in shorter time frames. The performance of the gold miners can differ from gold price returns due to a number of factors. Miners can hedge their output and may not benefit from any upside in gold returns. Further, and dare we say it in this current environment, but poor management decisions and poor capital allocation can destroy shareholder value which has occurred in the mining sector.
Another diverging factor is that gold mining ETFs often invest in silver and other precious metals. This is partially because the majority of the gold mining ETFs currently available don’t have to replicate their index fully. Therefore, nongold miners infiltrate ETF portfolios, and up to 20 percent of holdings can be unrelated to the gold mining business.
ETNS PROVIDING LEVERAGED EXPOSURE TO GOLD
Gold ETFs can be physically backed, with hefty gold storage vaults or as a note. A note differs from physical storage as it is a derivative product where the issuing institute promises investors the returns of the gold prices without the institute physically holding the underlying gold. This additional credit risk provides no additional return when compared to physically backed gold funds. As the notes are often leveraged, they are more expensive to hold on average. The largest exchange traded note, Direxion Daily Gold Miners Index Bull (“NUGT”) 2X Shares provides 2x leveraged exposure to a market-cap-weighted index of global gold and silver mining firms. This ETN has under $1bn AUM and is not cheap with a 1.19% expense ratio.
RISK IN USING GOLD AS A SAFE HAVEN ASSET
When reviewing gold as a safe haven asset, one must look at the worst-case scenario. In extreme crises governments have seized their citizen’s gold. Throughout history the most memorable is in 1933 during the great depression when the US nationalised all its citizen’s gold. Citizens were forced to sell their gold at well below market rates. Immediately after the “confiscation”, the government set a new official rate for gold that was much higher. Some fought in the courts but ultimately the government could not be stopped, and private gold ownership remained illegal in the US until the 1970s. This intervention was not unique; in 1959 Australia’s government put a law in place that allowed gold seizures from private citizens and, in 1966, to stop the decline in the Pound, the UK government banned citizens from owning more than four gold or silver coins and blocked the private import of gold.
Today, the situation is different because western economies have free-floating exchange rates so they have control over monetary policy and can allow capital to move freely. This means that during a crisis, they can print money and cut interest rates without having to impose controls on the likes of gold.
INVESTING IN GOLD THROUGH US
We do not invest directly into gold in our managed ETF solutions as we favour broad based equity and fixed income indices. We do however offer the facility to gain exposure to these exchange traded products through our low-cost execution only facility. Many investors like the warm, safety blanket of gold within their portfolio and it is a simple add to any client account for them to get the necessary safe haven exposure that they desire. You can chat to us about the specific ETFs available out there and why we may favour some over others.
Magwitch Offshore is a leading provider of Global Balanced ETF portfolios with products in all major currencies. Magwitch utilises an advisor distribution model and their portfolios are available through offshore endowment structures provided by some of the larger Insurers.