Gold ETFs share the same basic structure as all other ETF’s (refer article What are ETF’s) and can be bought and sold on the stock exchange like any other stock. All Gold ETF’s attempt to track the price of gold in some form or another. However there is however considerable diversity within these parameters and potential investors should carefully read the prospectus to know what they are investing in.
How they go about tracking the price of gold is where a level of complexity starts to kick in. Gold ETF’s and related products (including Exchange Traded Notes and Gold Close Ended Funds) are amongst the more difficult investments to categorize simply. For example some ETF’s hold physical gold whereas other gold ETF’s try to track the price of gold synthetically via derivatives (refer to the article Types of Index Funds for more information the different ETF tracking types)
Do differences in how ETF’s track the gold price matter?
In theory these differences shouldn’t matter but there may be considerable levels of risk (mainly counterpartyrisk) in some of the more exotic ETF structures. For example these structures can involve the funds gold being loaned, borrowed or used in some other income earning stream that investors should not only be aware of but also ought to be reimbursed for.
Australian Gold ETFs
One of the two gold products available via the Australian Securities Exchange (ASX) is not actually an ETF. It is a right created on-market by the Perth Mint to enable investment in gold structured as a fully paid call option with each ownership interest entitling the holder to one hundredth of a troy ounce of physical gold, exercisable at any time (PMGOLD). Each PMGOLD ownership interest is fully covered by gold owned by the Perth Mint, the majority of which is stored in its vaults in Perth.
Whilst this structure is much simpler than most, frankly it is a little hard (read impossible) for the layman investor to fully assess the risk of this structure (not being alarmist but this is true of ETF structures in general). In the case of PMGold most investors will simply take the common sense view that the Perth Mint seems unlikely to go broke and with an expense ratio of 0.15% it is one of the least costly ways for an Australian investor to gain gold exposure.
The second Gold ETF listed in Australia is an ETF Securities product ASX: GOL which is backed by physical allocated gold held by HSBC Bank USA (the custodian). Only gold that conforms with the London Bullion Market Association’s (LBMA) rules for Good Delivery can be accepted by the custodian. Each physical bar is segregated, individually identified and allocated. Its expense ratio is 0.4%.
So how well do gold ETF’s actually work?
Recent volatility in the gold market is providing a good test, with gold recently suffering its worst two day drop in three decades. And gold ETF’s in the main, held up well.
A case in point is the biggest gold ETF in the US being the SPDR Gold Trust and this $51 billion ETF sailed through the rout with relative ease.
Even during the worst of the volatility the bid-ask spread, widened to as much as three cents, but given the circumstances that was not unusual. It indicates the market was liquid and investors could still get in and out of their positions with relative ease.
Another closely watched metric is how closely ETFs track their underlying investments. The SPDR Gold trust has tracked the gold price closely over the course of the various market routs. The market price of the ETF held almost entirely in a band of 0.1% above and below its intraday indicative net asset value (refer to How to Buy ETF’s article for more information on the intraday indicative value)