ETFs the path to gold

PORTFOLIO POINT: Gold ETFs have been outperforming the market over recent times, in line with the rising gold price. And the best thing is, they’re much more liquid than physical gold.

The time to seriously assess exposure to gold is now – but a question remains around the best way to do that.

Tim Treadgold explained on Monday why there’s particular value in gold at the moment (Iron ore’s golden carrot), as investors seek safety from looming inflation via monetary easing in Europe and the US, while South Africa’s troubled mining industry is now facing potential industrial action within  the gold sector.

The gold price has been rising steadily over recent weeks and, when this is coupled with potential currency gains from a turnaround in the Australian dollar as a result of weakening terms of trade, gold stands out even further as a way to make money in a tough global economy.

Go forth and buy gold, then!  Though your choices are now much wider than the traditional method og buying gold bars and putting them in a vault…certainly the most popular route for the retail investor over the last decade has been to explore stock exchange listed products such as ETFs (Exchange Traded Funds).

ETFs and gold

Gold is an unusual asset for several well-documented reasons. As a commodity it is accumulated, not actually used, so almost all gold that has been produced in the past several hundred years is stored. As a currency it has moved away from the standard underpinning the developed world – what John Maynard Keynes called the “barbarous relic” – and then partly back again as investors use exchange rates to improve the value of gold holdings. As an investment it has a low correlation to other asset classes, and is generally viewed as an inflation hedge.

These aspects mean gold can be invested in via different avenues. The simplest way is to just buy the end product, real gold. The benefits of this are simplicity and tangibility but this is not particularly practical, nor very liquid. There is also an added cost of storage and security for physical gold, and, while today the process is more standardised and accessible than a faded map with a dotted line and an X, it’s a cost to be considered.

At the other end of the spectrum are stock exchange listed gold producers. Even though gold miners generally do benefit from higher gold prices, these gains can be offset by company-specific or macroeconomic factors.

As Tim Treadgold points out: “Middle ranking gold stocks such as Medusa, Kingsrose, Troy and Resolute all retreated [last week], even as the gold price rose in all currencies.” Meanwhile a one-time retail favourite Kingsgate Consolidated (KCN), with a share price off more than 40% since February due to sovereign risk factors at its Thailand mine and a costly acquisition causing headaches in South Australia.

No surprise then that investors sobered by company-specific reversals have been rushing towards purer commodity plays offered by ETFs. Indeed the world’s most popular gold-based EFTs are now significantly bigger than any listed gold miner.

For example State Street’s SPDR Gold Trust is the second-largest exchange-traded product in the world with assets under management, at $US65.2 billion.

Tom Keenan, a director of Ishares Australia – one of the biggest ETF providers in the market -  says the success of gold ETFs comes from their physical backing.

 “[A gold] ETF can actually very easily warehouse actual physical bullion. That’s why, particularly, gold ETFs have been very successful, because they’re such a good way to track the spot price of that particular market,” he says.

 “When you get into soft commodities you need to start getting into futures to replicate the performance of that particular commodity, and that’s when things can get more complicated.”

It was Australia that pioneered the original gold product of this kind in 2003. Formerly known as Gold Bullion Ltd, ETFS Physical Gold (ASX:GOLD) securities are redeemable preference shares, with an entitlement to physical, allocated gold held by HSBC Bank.

The shares trade on the ASX, and because they are effectively a beneficial interest in one-tenth of a troy ounce gold in a London vault – conforming to “Good Delivery” standard – they move with the London Bullion Market Association spot gold price, minus a 0.39% per annum management fee. In this way they act roughly like an ETF.

The fee is important, as it gradually erodes each share’s effective entitlement to the real gold. ETF Securities explains “that entitlement changes daily to reflect the accrual of the management fee”.

However, there is only one conventional ETF tracking gold listed on the ASX at the moment: the BetaShares Gold Bullion ETF – Currency Hedged (ASX:QAU). This is a fund backed by about 23,000 ounces of gold bullion held by JP Morgan Chase in London, with a currency hedge against the AUD/USD exchange rate.

The BetaShares website says this is to provide “for a ‘purer’ exposure to the gold price”, however it may deter some investors looking to make a bet on both the gold price rising in US dollars and the Australian dollar falling against it – thereby realising a higher Australian dollar profit.

Click to enlarge

Finally, there is the innovative Perth Mint Gold structured product (ASX:PMGOLD). This is an ASX-listed product which is designed to be an ongoing call option exercisable over one-hundredth of a troy ounce of 99.99% purity gold at the Perth Mint. Advantages include a management fee of just 0.15% and the fact it is redeemable for real gold, while also being more liquid and tradable than the equivalent real gold would otherwise be.

Gold, it seems, is definitely back in favour. In August, billionaire US hedge fund managers George Soros and John Paulson both lifted their holdings in the SPDR Gold Trust, while the world’s biggest bond-fund manager, Pacific Investment Management (PIMCO), increased the gold holdings in its $21 billion Commodity Real Return Strategy Fund to 11.5% of total assets.

And, in the lead-up to the US Presidential election, elements within the Republican Party  have launched an ambitious campaign for the establishment of a “gold commission”, to consider restoring a link between the precious metal and the US dollar.

Practical difficulties aside, if this long-shot ever did get up it would require heavy bullion buying by the US government – providing yet another boost for the precious yellow metal.