Gold is a go-to commodity during troubled times, and exchange-traded funds (ETFs) have made it easier than ever to hedge a portfolio. For example, the SPDR Gold Trust (GLD ) experienced over $1.3 billion in net inflows in the days following Britain’s decision to leave the European Union as investors sought a safe-haven asset class. Investors in these ETFs don’t need to worry about trading futures contracts on margin or storing physical gold bullion.
Of course, there are many different types of gold ETFs for investors to consider. Physical gold ETFs hold actual gold bullion in giant vaults, which provides investors with direct exposure to the commodity’s price. Gold mining ETFs take a different approach by investing in the equities or bonds of gold mining companies, which provides indirect exposure to the commodity since these equities tend to appreciate when gold prices are on the rise.
In this article, we will take a look at the key differences between physical gold ETFs and gold mining ETFs, as well as how investors can decide between them.
Physical Gold ETFs
Physical gold ETFs reflect the performance of the price of gold bullion, less the expenses of their operations, by cost-effectively buying and selling actual gold that is stored in vaults. Although futures contracts were used in the past — providing ETFs with the right to gold bullion — the 2008 financial crisis led to concerns over the validity of these contracts and eventually steered the industry toward holding physical gold bullion at custodian banks.
For example, consider this description from the SPDR Gold Trust’s prospectus:
“As of December 31, 2015, the Custodian held 20,691,044 ounces of gold on behalf of the Trust in its vault, 100% of which is allocated gold in the form of London Good Delivery gold bars with a market value of $21,979,061,920 (cost $25,333,180,858) based on the LBMA Gold Price AM on December 31, 2015. Subcustodians held nil ounces of gold in their vaults on behalf of the Trust and 38,268 ounces of gold were payable by the Trust in connection with the creation and redemption of Baskets.”
Often times, investors looking for a hedge against an economic downturn will purchase physical gold ETFs because they provide unparalleled access to the actual commodity. It’s quite literally the next best thing to purchasing physical gold and storing it in a safe deposit box.
Some popular physical gold ETFs include:
Gold Mining ETFs
Gold mining ETFs are similar to traditional ETFs in that they hold a portfolio of equities and bonds. In this case, these equities and bonds are focused on the gold mining sector, which tends to move in conjunction with gold prices. These ETFs are typically subdivided into large mining companies that are profitable and junior mining companies that are typically in development stage and may not be generating any revenue at all.
For example, consider this description from the Van Eck Gold Miners ETF’s prospectus:
“The Fund normally invests at least 80% of its total assets in common stocks and depositary receipts of companies involved in the gold mining industry. Such companies may include small- and medium-capitalization companies and foreign issuers. The Gold Miners Index is a modified market-capitalization weighted index primarily comprised of publicly traded companies involved in the mining for gold and silver.”
Often times, investors looking to capitalize on the rising price of gold — more so than hedge a portfolio against risk — will purchase gold mining ETFs because they tend to have a bit more volatility than physical gold ETFs and may amplify gold’s sentiments (see Figure 1 below).
Some popular gold mining ETFs include:
The Bottom Line
Investors have two options when buying gold ETFs: physical or mining ETFs. Physical ETFs are typically used as a hedge against a downturn since they are backed by tangible gold bullion. By contrast, gold mining ETFs are more speculative investments for traders who believe gold prices are on the rise and are looking more for capital gains than safety.