Next Generation Of Gold ETFs

by on August 23, 2010 | ETFs Mentioned:

Global X, the ETF issuer that burst on to the scene with China and Brazil sector ETFs, recently filed with the SEC to offer a new ETF that would focus on companies engaged in exploration for gold. The proposed fund would seek to replicate the Solactive Global Gold Explorers Index, a benchmark made up of the largest and most liquid listed companies that are active in the exploration of gold. The SEC filing was light on many critical details, but gave a glimpse into a fund that could be a big hit with investors looking for creative ways to establish precious metals exposure.

High Risk, High Reward

This new fund would offer precious metal hungry investors yet another way to play gold, this time in an extremely speculative and high-risk manner. Because few properties which are explored are ultimately developed into gold-producing mines, the exploration business is inherently volatile and risky. Exploring a potential gold deposit often incurs major expenditures related to drilling, construction, and processing facilities at a site. In addition, many mineral exploration companies operate at a loss for prolonged periods of time, and are dependent on securing equity and/or debt financing. In uncertain economic environments, that can be hard to come by, further jeopardizing operations. Among the other risks cited in the filing: competitive pressures in the gold exploration industry, the price of gold bullion, import and export controls, liability for environmental damage, and mandated expenditures for safety and pollution control devices [see Gold ETFs: Where Do They Go From Here?].

Of course, along with this significant risk comes potential for impressive returns. Explorers who strike gold can hit it very big very fast, especially with market prices for gold hovering near record highs. With demand for the safe haven unlikely to ease any time soon–public filings show that hedge fund managers and investment banks are buying up massive quantities of the metal–explorers should have no trouble finding a market for their end product.

A gold explorers ETF could have appeal to investors who are interested in accessing the sector but unwilling to concentrate holdings in a single company given the volatility inherent in a firm’s exploration activities. By offering efficient exposure to a basket of securities, that company-specific risk can be diversified away while still making a play on gold explorers [also read Hedge Fund Are Buying Up Gold ETFs, Should You?].

Continuing The Trend

This new fund will continue Global X’s pursuit of expanding beyond emerging market ETFs and into commodity producing equities. The company already boasts a Silver Miners ETF (SIL),a Lithium ETF (LIT), and a Copper Miners ETF (COPX). These funds have met varying degrees of success in the marketplace so far with SIL and LIT racking up $63 million and $21 million, respectively. The copper miners fund has been slow to gain traction, with assets currently standing at just about $2 million [also see Mining ETFs: Ready To Rally?].

The proposed ETF also represents a continued evolution of the gold ETF space. The original funds were physically-backed ETFs that held gold bullion in secure vaults. Subsequent variations included futures-based gold ETFs and a couple products focusing on gold miners. In addition to the Gold Miners ETF (GDX)–which focuses on stocks of companies engaged in the extraction of gold–Van Eck offers a Junior Gold Miners ETF (GDXJ) that includes more speculative firms engaged in the development of new sources of gold either through greenfields exploration or the use
of new geologic models to prospect for gold in overlooked or abandoned properties.

Global X is no doubt hoping to match the incredible success that GDXJ has seen over the past year. The fund from Van Eck has seen its assets swell to over $1.2 billion and currently has over 1.5 million shares trading hands everyday. Presumably, the new Global X fund would maintain some overlap with the existing Market Vectors ETF; further filings should shed more light on the details [also read Ten Intriguing ETF Storylines].

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Disclosure: Eric is long LIT.