For centuries, gold has been seen as a safe haven and a store of value. Why should modern times be any different? Today, investing in gold is easier than ever, thanks to exchange traded funds (ETFs). If your clients are clamoring for some exposure in their portfolios, read up on the ins and outs of this unique asset class.
Gold has long been used as a hedge against political and economic uncertainties, and central banks around the world back their currency with gold reserves. Gold is the metal that is seen as a “safe haven” in times of world turmoil, prompting some investors to buy gold bars, which always will have some value. Gold is also used widely in industry, including computers and telecommunications.
Some will simply never be comfortable with owning gold they can’t see and for them, taking physical possession makes the most sense. But if you simply want exposure, consider the benefits of owning gold ETFs.
Gold’s Many Uses
What’s great about gold is that it tends to have a low correlation to other asset classes, which basically means that it is a great diversifier. Historically, gold is negatively correlated to stocks and other financial instruments. In utilizing the proper combination of gold with other assets, an investor may reduce the overall volatility and risk of his or her portfolio.
Gold is used for a variety of reasons because it’s seen as an uncorrelated asset. On days when the markets are trading lower, you will generally see gold ETFs and other safe-haven tools, such as the Japanese yen and U.S. Treasury bonds, trending higher. That hasn’t changed – gold is still a rainy day asset because it’s seen as a better store of value than equities and other commodities when times are tough.
This is especially evident when there is weakness in the U.S. dollar. In this situation, gold is an effective hedge because it holds its value even as the dollar is losing it. This, in turn, causes more investors to flock to the security of gold, which further pushes gold prices up.
Gold has been an effective hedge against inflation. Though the risk of inflation is low now, eventually the money that central banks have put into the financial system may pose the risk of significant future inflation. Aware of this, many investors are building up their gold stockpiles now.
Gold is also a store of value independent of the financial machinations of balance sheets and earnings projections. Furthermore, during periods in which prices contract, or deflationary periods, the relative purchasing power of gold can still remain high.
Lastly, gold is a hedge in times of geopolitical strife. Any large crisis or uncertainty in the world will usually send people to the safety of gold.
The Benefits of Gold ETFs
Why would you own a gold ETF instead of actual gold? Simply put, it’s more convenient.
Owning a gold-focused ETF is a good way to get physical exposure to gold without the hassle of taking physical possession – finding storage, paying for storage and so on. Each share of a physically-backed gold ETF is just that: backed by a piece of gold.
This gold is stored in secure vaults in London and Switzerland, and the holdings within are audited and inspected on a regular basis. Some investors aren’t comfortable with this, and as stated above, if you’re not, then gold ETFs may not be the right choice for you.
You have three options to invest in physically-backed gold ETFs:
- SPDR Gold Shares (NYSEArca: GLD)
- iShares COMEX Gold (NYSEArca: IAU)
- ETFS Physical Swiss Gold Shares (NYSEArca: SGOL)
The differences between the three come down to both where the gold is held and the expense ratio of each of the funds. After recently slashing its cost, IAU is the cheapest, with a 0.25% expense ratio. GLD and SGOL have a 0.40% and 0.39% expense ratio, respectively. SGOL stores its gold in Swiss vaults; GLD and IAU have their gold stored in London.
The Future of Gold
Record market volatility and uncertainty has pushed gold demand to new heights and prices to new records. Asian countries are particularly large consumers of gold; the commodity is not just a store of wealth or a safe haven, but it’s also heavily used in jewelry.
In addition, ETFs have also become one of the world’s largest holders of gold bullion and demand for ETFs will only drive the fund providers to allocate more gold into their vaults. In fact, the World Gold Council recently said that quarterly demand for gold soared 414% in the second quarter of 2010, driven primarily by ETFs.
While gold isn’t necessarily a volatile instrument, it has periods where it comes in and out of favor. To effectively invest in gold ETFs, you need to watch them for any signs of a drop-off and act accordingly.
From a tax viewpoint, physical gold and physically-back gold ETFs are treated as collectibles. If held for less than one year, they’re taxed at the normal 15% rate. If held for more than a year, they’re taxed at a 28% rate.
If physically-backed gold ETFs aren’t your style, there are other types of gold funds:
- Market Vectors Gold Miners (NYSEArca: GDX) and Market Vectors Junior Gold Miners (NYSEArca: GDXJ) both hold the stocks of mining companies. These ETFs only track the performance of these companies – they do not track the spot price of gold. The companies held in these funds tend to perform better when the price of gold is elevated, as it is now.
- PowerShares DB Gold (NYSEArca: DGL) owns gold futures contracts, rolling them forward instead of taking physical delivery each month. Like all futures-backed ETFs, this fund is a partnership and generates a K-1 at tax time.
The opinions and forecasts expressed herein are solely those of Tom Lydon, and may not actually come to pass. Information on this site should not be used or construed as an offer to sell, a solicitation of an offer to buy, or a recommendation for any product.