Investment Road Test: Gold Bullion Securities ETF

PORTFOLIO POINT: Gold is a safe hedge against inflation, and this ASX-listed ETF is an easy and cheap way of buying the yellow metal.

If you want to hedge against higher interest rates and inflation there is no substitute for holding physical gold.

Before you turn the page (maybe you hold gold mining stocks like Newcrest), consider the urgency needed to cover these risks. You don’t have to agree with everything “Doctor Doom” Marc Faber writes to believe that interest rates are going higher, probably substantially, driven by global bond issuance as governments cover their GFC recovery package expenditure.

This will directly stimulate inflation in countries like the US, where home mortgage rates are pegged to the government bond rate. In countries like Australia the problem with rising inflation, driven here by the global recovery’s demand for resources, has already led the Reserve Bank to start talking about rising rates and inflation. The inflation problem is compounded by the massive liquidity in the system, with timely withdrawal being problematic (as former Fed chairman Alan Greenspan now realises). While bank earnings tend to do well in rising-rate environments, holding bank stocks isn’t as effective an inflation hedge as gold.

The investment merits of gold reflect its low correlation with stockmarkets, as well as the inverse correlation between gold and inflation. Gold rises in value as inflation rises, and in recent years it has been an important store of wealth for the many emerging market nations, which have moved their current accounts into surplus. Specifically, nations such as the Middle Eastern oil producers, China and many others are investing in gold as the risk of their traditional investments, such as US bonds, keep rising.

Observers of the gold price will have noted over the past few years that it has risen in price along with oil, and at the same time as the US dollar has been falling in value. This trend is unlikely to end in the short to medium future.

ASX-listed exchange-traded funds (ETFs) are an easy and low-cost way to buy alternative assets like gold without the risks associated with buying producers or physical gold (see Gold, for all seasons). Traded on the ASX like any other listed security, ETFs track the value of the underlying instrument or, in this case, commodity.

The World Gold Council-sponsored Gold Bullion Securities ETF (GOLD) has experienced strong growth since launch, making it one of the largest ASX-listed ETFs. This particular ETF is a securitisation vehicle and issues redeemable preference shares with each share represents a direct beneficial interest in a tenth of an ounce of physical gold.

The shares hold their interest in allocated gold, held for investors by HSBC acting as custodian. This provides good investor security as well as the means by which premiums or discounts between physical gold and GOLD ETF prices can be removed. Like most ETFs this mechanism involves market makers moving between physical gold and the GOLD ETF, and observed tracking error is very low.

But they are not without their critics within the broader investment community. Over the past two years of volatility, the demand for gold ETFs has risen faster than it could be produced, leading some investors to question (see Can Goldlink come back?) whether or not a gold ETF – which is ultimately a derivative – is the risk-averse investment they are looking for.

ETF fees are low at 0.4% pa and are deducted by reducing investors’ entitlement to physical gold, current entitlement is to 97.88% of the gold backing each ETF share. The GOLD website refers to a PricewaterhouseCoopers analysis showing that portfolios can benefit by up to 5% allocation to gold (although the methodology used for the study relies on the Sharpe ratio concept, which was derided in a recent paper from the Australian Prudential Regulation Authority analysing Australian managed fund performance).

If you are serious about protecting your investments you should carefully consider inclusion of gold in your portfolio – and the GOLD ETF is one of the easiest and cheapest ways of doing so.

The score: 3.5 stars
1 Ease of understanding/transparency
1 Fees
0.5 Performance/durability/volatility/relevance of underlying asset
0.5 Regulatory profile/risks
0.5 Innovation

Tony Rumble is the founder of the ASX-listed products course LPAC Online, a provider of investment training to financial services professionals.