Physically-Backed Gold ETFs Provide Convenience

The global economic crisis isn’t getting any better. Yes, we see rallies in various markets, but they’re getting weaker and shorter. The smart money is taking the opportunity to sell on strength.

I don’t know how it will all end. As I said in last week’s column, picking the bottom is tough even in the best of circumstances. I can’t really blame anyone who is looking for a safe haven right now. Many people think gold is a good place to hide.

Are they right? I think so. Subscribers to my International ETF Trader service bagged some nice profits in a gold-based ETF earlier this year. They’ve been holding another one since last summer. (If you want to know exactly which one, click here to order.)

Today I’m going to review some ways you can get gold exposure through exchange-traded funds. First, though, let’s look at the big picture for this most precious metal.

Remember $500 Gold?
It Wasn’t So Long Ago

To say that gold was strong the last few years is an understatement.

Gold has moved a long way in just a few years.

Of course, the only reason you buy gold (or anything else) is because you think it will outperform whatever asset you would otherwise own — U.S. dollars, in this case.

So it appears that a substantial number of people would rather hold gold than greenbacks. You could say the same for most other paper currencies.

People can change their minds, of course. If those who presently own gold decide they would rather have dollars, yen, stocks, Treasury bonds, sea shells, or whatever, gold prices could collapse.

Likewise, the gold price in dollar terms could go up quite a bit further if more people decide to buy.

I can’t predict what the crowd will do, but I think gold still has a lot of upside potential. If you agree, ETFs make it easy to get aboard. Let’s start with the two biggest gold-based ETFs:

• SPDR Gold Trust (GLD)

• iShares Gold Trust (IAU)

GLD is by far the most popular exchange-traded gold proxy. In fact, with assets of around $65 billion as of early October, it is one of the most popular ETFs of any type.

GLD is bigger, but IAU is no small fry — it currently holds about $9 billion in gold bars.  

IAU and GLD have very similar structures. In both cases, the ETF shares are backed by physical gold stored in a secure vault. The shares fluctuate but typically move in line with the cash price for gold bullion.

Here’s a key distinction, though, and why it could make a difference which ETF you choose:

• Each GLD share represents 1/10 of an ounce of gold, while …

• Each IAU share is valued at 1/100 of an ounce of gold.

So if the world gold price is $1,600 per ounce, you’ll see GLD trading for around $160 and IAU around $16 per share.

The smaller increments in IAU make it easier to fine-tune your portfolio. Here’s an example. Say you want to put $1,000 to work in a gold ETF. This represents 10 percent of your $10,000 nest egg. (For simplicity, we’ll ignore transaction costs.)

If you use your $1,000 to buy GLD at $160 a share, you can buy six shares for $960. Or you can buy seven shares for $1,120. That means you allocated either 9.6 percent of your money, or 11.2 percent to GLD. There’s no way to get any more precise.

Cut the pie into smaller pieces and you can have exactly the right amount.

If your $1,000 goes to IAU, you could buy 62 shares for a total of $992, or 63 shares for $1,008. This is still not exactly where you want to be — but it’s quite a bit closer.

The small increments are less important if you’re trading larger amounts, of course. If, like me, you want to keep your gold investment within specific parameters, IAU’s low share price can be a big help. IAU also has a lower expense at 0.25 percent versus the 0.40 percent for GLD.

Is the Gold Really There?

Any investment in gold involves some degree of trust that the gold is really there. That’s the case even with gold coins and bars. They can be counterfeited or the metal diluted with impurities. Unless you are a properly equipped chemist, you may never know the difference.

Your gold is stored in huge vaults, but you can’t get in to see it. Only the auditors and a few others are allowed inside.

The same is true of gold ETFs. Sure, they say they have so many ounces of gold in a vault someplace. Do they really? Some conspiracy theorists would have you believe they don’t. However, I think it’s a pretty safe bet.

A bigger issue — even if you presume the ETF has stored away the correct amount of real gold — is that no vault is secure from government seizure. Bureaucrats do crazy things sometimes. So it helps to pay attention to who has jurisdiction in the place your ETF keeps its gold.

GLD and IAU mostly use vaults in New York, London, and Toronto. A couple of newer ETFs offer a way to diversify your gold holdings geographically:

• ETFS Physical Swiss Gold Shares (SGOL) stores its gold in Switzerland.
• ETFS Physical Asian Gold Shares (AGOL) stores its gold in Singapore.

I personally don’t see much need for SGOL and AGOL, but they’re available if this feature is important to you.

Finally, I want to mention Sprott Physical Gold Trust (PHYS). I’m not calling it an ETF because it is actually something else. PHYS lacks the mechanism that keeps the other gold-based ETFs trading in line with the world gold price. Instead, PHYS is a closed-end fund that can trade at a significant premium or discount to actual value. That may be good or bad, of course. Just be aware of the possibility.

With ETFs, investing in gold has never been easier or more convenient. Consider them carefully if you want part of your money in precious metals.

Best wishes,

Ron