Gold ETF Investing: Closer Look At All The Options

by on October 18, 2010 | ETFs Mentioned:

One of the major stories of the past few months has been the impressive rally in gold prices, which have repeatedly touched new record highs in recent sessions. Fueled by concerns about the impact of further quantitative easing and weakness in the U.S. dollar, gold has climbed steadily higher even as equity markets have showed somewhat surprising strength. The stellar performance of the yellow metal, along with a slew of options for establishing both direct and indirect exposure, has sent interest in precious metals to new highs as well.

In recent years, options for achieving exposure to gold have expanded considerably, thanks in large part to the introduction of various exchange-traded funds. Funds offering exposure to gold prices through equities of companies engaged in the extraction of the metal have seen huge cash inflows, highlighting the ongoing evolution of the ETF industry. But the original means of accessing gold–through an ownership interest in physical bullion–remains tremendously popular as well. Through the first three quarters of 2010, cash inflows into physically-backed gold ETFs topped $8 billion, with three different funds taking in at least $500 million [see all gold ETFs]. And while there are significant similarities between the various gold ETF products out there, there are some subtle differences as well. Below we highlight four of the most popular ETF options for establishing exposure to gold, highlighting some of the nuances that make each unique [for more ETF insights, sign up for our free ETF newsletter]:

SPDR Gold Trust (GLD)

Why GLD Is Unique: With AUM of more than $50 billion GLD is the second largest U.S.-listed ETF by total assets, trailing only the S&P 500 SPDR (SPY). This ETF holds approximately 1,300 tonnes of bullion, making it one of the largest holders of gold in the world (China, the world’s sixth-largest holder of gold, has reserves of approximately 1,000 tonnes). GLD’s average daily trading volume is nearly 15 million shares, making this fund one of the most liquid ETFs available.

GLD has become a popular holding of many well-known hedge fund managers in recent months, as worries about inflation and a sinking dollar have intensified. Among those with major positions in the Gold SPDR are George Soros, John Paulson, and Eric Mindich [see Legendary Investors Go All In On GLD].

HSBC serves as the custodian for GLD, and the fund charges an expense ratio of 0.40%. That makes GLD one of the top-earning ETFs in terms of management fees generated; the annual run rate of about $220 million trails only the iShares MSCI Emerging Markets Index Fund (EEM), which hauls in close to $325 million in annual fees.

iShares COMEX Gold Trust (IAU)

Why IAU Is Unique: The iShares gold ETF is the second largest in this category by total assets, but is only a fraction the size of GLD. While the underlying holdings are nearly identical–both funds hold bars of gold bullion stored in secure vaults–there are some nuances in the structures of these funds that differentiate the two largest gold ETFs. First–and most importantly to some investors–IAU charges an expense ratio of 25 basis points, which makes it considerably cheaper than GLD.

But there are some less obvious differences as well. iShares recently named JPMorgan as IAU’s custodian, and also tweaked the structure of the fund to offer 100% daily allocation of the underlying gold bullion. Gold is described as “unallocated” when an investor has no ownership interest in any particular gold that the custodian holds. On the other hand, gold is allocated when specific bars held by the custodian are identified as property of the investor holdings the allocated account. According to the terms of IAU’s agreement with JPMorgan Chase, there can be no gold in unallocated form in the custodian’s account. As such, no additional shares of IAU can be created until the custodian has informed the trustee that it has allocated the amount of gold corresponding to the creation basket to the trust’s account.

Unallocated gold generally makes up a relatively minor portion of a physically-backed fund, and the frequency of the allocation process won’t necessarily have a material impact on an investor’s bottom line return. But for some investors, the fact that IAU guarantees shareholder claims on the gold it represents on a daily basis–reducing exposure to potential counterparty risks associated with unallocated gold exposure in the process–may be an appealing characteristic. IAU is also unique in that each share represents approximately 1/100th of an ounce of physical bullion; each share of the other two physically-backed gold funds corresponds to approximately 1/10th of an ounce of gold. So each share of IAU currently trades at about $13, compared to approximately $130 for GLD and SGOL.

One other unique fact about IAU: the gold bullion underlying ETF shares is stored in three different countries. Vaults are located in New York, Toronto, and London.

ETFS Physical Swiss Gold Shares (SGOL)

Why SGOL Is Unique: SGOL is the smallest of the three physically-backed gold ETFs available to U.S. investors, but this fund still has more than $1 billion in assets. SGOL’s expense ratio of 0.39% makes it slightly cheaper than GLD, but still 14 basis points more expensive than IAU. JP Morgan Chase also serves as the custodian for SGOL.

SGOL is unique primarily because of the physical location of the underlying gold. As the name of the fund suggests, bullion held by SGOL is held in secure vaults in Switzerland, a distinction that may provide peace of mind for investors concerned that a repeat of the gold confiscation of 1933 is a possibility [see Why A Swiss Gold ETF Makes Sense].

PowerShares DB Gold Fund (DGL)

Why DGL Is Unique: Unlike the three funds profiled above, DGL offers exposure to gold not through a physically-backed approach, but rather via a futures-based strategy. DGL seeks to replicate the performance of the Deutsche Bank Liquid Commodity Index-Optimum Yield Gold Excess Return, a benchmark composed of futures contracts on gold. While DGL will exhibit a near-perfect correlation to spot gold prices, the returns delivered by the two strategies won’t always be identical. So far in 2010, DGL has lagged behind physically-backed gold ETFs by about 100 basis points. But in certain environments–perhaps when interest rates recover from record lows–a futures-based strategy may be advantageous.

The tax ramifications of futures-based products can be different from those of physically-backed products. Investors in GLD, IAU, and SGOL are taxed as if they own physical bullion, which means incurring the 28% rate applicable to “collectibles” for long-term gains. Gains and losses on futures contracts within an ETF, however, are treated for tax purposes as 60% long-term and 40% short-term, regardless of the actual holding period.

Disclosure: No positions at time of writing.