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The Definitive Gold ETF Guide: Gold Bullion ETFs 101

by Andy H on October 29, 2009 | ETFs Mentioned: DGL • DGZ • DZZ • GDX • GLD • GOE • GP • HAP • IAU • SGOL • UBG

The label “gold bug” may suggest a kooky old man who spends a lot of time in his basement reading conspiracy theory newsletters. The truth, however, is that there are many legitimate reasons to trade in gold and its derivatives. Gold has been proven time and time again to be an excellent “safe haven” investment, a holding that will appreciate in value during times of economic uncertainty. As such, gold may offer some valuable hedging and diversification benefits for a long-term portfolio.

Gold ETFs For this reason, gold is also an effective “dollar hedge” - it tends to rise as investors become uneasy with the idea of keeping their holdings tied up in the U.S. currency. In recent years, China has begun shifting its reserve holdings away from investments in U.S. Treasuries and towards hard currency (gold and silver). China has also encouraged its citizens to beef up their precious metals holdings, a sign that gold may play an increasingly important role in the future.

Five years ago, it was difficult for investors to efficiently invest in gold bullion. But the development of the ETF market has changed that. Gold ETNs and ETFs are an efficient way to invest in the metal without dealing with the associated “headaches” of holding a physical amount of gold in your possession. There are a number of exchange-traded products offering exposure to gold prices. But not all gold ETFs are created equal. Here’s a quick rundown of factors to consider when making an investment in a gold ETF. ETFdb Pro members can learn more in our Precious Metals ETFdb Category Report (if you’re not a Pro member yet, you can sign up for a free trial here).

How Gold ETFs (And ETNs) Work

Since gold is a commodity, many investors assume that gold ETFs are essentially identical. While there are a number of factors that make the various gold ETF products unique, the most important is the manner in which they achieve exposure to gold prices. Some gold ETFs buy and physically hold gold bullion (i.e., they have massive collections of gold bars), while others invest in futures contracts. Physically-backed gold ETFs will obviously track the spot price of gold more accurately, since the value of the underlying holdings depends solely on the market price of bullion.

ETFs that track gold prices using futures contracts will track the spot price of bullion very closely, but may deviate occasionally due to phenomenons such as backwardation and contango in commodity futures markets.

Ticker	ETF	Exposure	Vault Location	Expense Ratio
GLD	SPDR Gold Trust	Gold Bullion	U.S.	0.40%
IAU	iShares COMEX Gold Trust	Gold Bullion	U.S.	0.40%
DGL	PowerShares DB Gold Fund	Gold Futures	n/a	0.50%
SGOL	ETFS Physical Swiss Gold Shares	Gold Bullion	Switzerland	0.39%
UBG	UBS E-TRACS CMCI Gold Total Return	Gold Futures	n/a	0.30%

For investors with significant gold holdings, diversification across custodians and geographies may be desired as well. While a repeat of the U.S. gold confiscation of 1933 is unlikely, it isn’t completely impossible. Some investors may sleep better at night knowing their gold is securely stored in multiple locations in different parts of the world. For this reason, London-based ETF Securities offers an ETF that stores its gold in Switzerland, a country long known for being friendly to investors. “The feedback that we’ve received from investors is that they would like to be able to hold their gold in Switzerland for a number of different reasons including diversification of geography, vault, custodian and issuer,” said William Rhind, Head of Sales and Marketing for ETFS Marketing following the launch of SGOL.

Gold bugs will also see the benefits of diversifying their holdings across custodian. While the likelihood of any shenanigans involving gold holdings is incredibly remote, the lat two years have taught us to never count anything out. JP Morgan serves as the custodian for SGOL, while HSBC and the Bank of Nova Scotia serve as custodians for GLD and IAU.

For more information about ETF strategies for wealthy individuals, see our Free Guide to ETFs for Very High Net Worth Individuals.

Precious Metals ETFs

In addition to ETFs that invest exclusively in gold, there are two precious metals funds that offer exposure to both gold and silver. Both the PowerShares DB Precious Metals Fund (DBP) and iPath Dow Jones-UBS Precious Metals ETN (JJP) utilize futures contracts to tract the price of a basket of precious metals that is tilted heavily towards gold.

Ticker	ETF	% Gold*
DBP	PowerShares DB Precious Metals Fund	80.0%
JJP	iPath Dow Jones-UBS Precious Metals ETN	68.5%
*Reflects base weighting for DBP and 9/30/09 weighting for JJP

“Indirect” Gold ETFs

For investors who are uneasy about investing directly in commodities (or futures contracts on commodities), there are ways to gain exposure to gold prices while sticking to equities. Van Eck offers a line of Market Vectors ETFs that invest in stocks of companies engaged in various commodity-intensive businesses, ranging from steel mills to coal miners. The Gold Miners ETF (GDX) is based on an index that provides exposure to publicly-traded companies engaged in mining for gold.

Because the revenues of these companies are directly related to the market price for gold bullion, there tends to be a strong correlation between these equities and gold prices. Since GDX was launched in May 2006, it has maintained a correlation with GLD of approximately 0.35.

Another option is the Junior Gold Miners ETF (GDXJ) also from Van Eck. This fund, with an expense ratio of .60%, focuses on equities of small and mid cap companies engaged in the development of new sources of gold either through greenfields exploration or the use of new geological models to search for gold in overlooked and abandoned areas.

The Hard Assets Producers ETF (HAP) offers limited exposure to companies engaged in the precious metals business, but this fund’s exposure is more heavily tilted towards energy and agriculture companies.

Leveraged And Inverse Gold Exposure

The options for investing in gold through ETFs don’t stop with “plain vanilla” long funds. While many long-term investors will want to hold a small amount of gold in their portfolios, yellow metal isn’t exclusively for buy-and-holders. Speculators with strong opinions on short-term price movements of the “yellow metal” There are several exchange-traded products that offer leveraged and inverse exposure to gold prices:

Ticker	ETF	Inverse?	Leverage	Time Horizon
DGP	PowerShares DB Gold Double Long ETN	No	200%	Monthly
DZZ	PowerShares DB Gold Double Short ETN	Yes	-200%	Monthly
UGL	ProShares Ultra Gold	No	200%	Daily
GLL	ProShares UltraShort Gold	Yes	-200%	Daily
DGZ	PowerShares DB Gold Short ETN	Yes	n/a	Daily