Investors have been turning to gold as portfolio protection amid increased volatility in the stock markets across the globe, driven by failing Brexit negotiations, concerns over the lingering US government shutdown and worries about faltering growth in Europe and China.
Data from exchange-traded fund (ETF) analysis platform TrackInsight shows that gold ETFs have attracted some €2.5bn in net inflows over the past month to 15 January and have returned 3.7% on average over the period. The gold price is now sitting at $1,292 per ounce, the highest in six months.
Gaining access to gold through an ETF has the advantage of being a cheaper, easier and more secure method than buying physical gold bullion and a more accurate way of tracking the gold price than a fund investing in gold miners.
Laith Khalaf, senior analyst at Hargreaves Lansdown, said: “A gold ETF would be my preferred way to add gold exposure to a portfolio.
“Buying bullion is more expensive, you have to store and insure it, while gold shares are tied into the equity market, so there are other things affecting them.”
Another advantage to holding a gold ETF instead of physical gold, he added, is that it is easier to include in an ISA or SIPP, meaning the returns from the investment are tax free.
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Investors need to be aware that for regulatory reasons most EU-domiciled gold ETFs are actually ETCs – exchange traded commodities. They are very similar to gold ETFs, but there is a difference in the structure.
An ETF buys or sells the underlying commodity it is meant to track or futures contracts on this commodity, while an ETC does not do this directly. It is a note underwritten by a bank and collateralised by physical commodities to reduce the underwriter’s default risk. In most cases, however, this difference in structures has no impact on returns.
Oliver Smith, portfolio manager at IG, said: “Investors should not have concerns, but if in doubt they should stick to the brand names they recognise.”
Physical or synthetic?
There are two types of gold exchange-traded products (ETPs) available to investors – physical and synthetic.
Physical gold ETPs hold a certain quantity of gold bullion in a vault on behalf of investors. For example, iShares Physical Gold holds assets with J.P. Morgan and outlines exactly which bars are held in their vaults.
Frank Spiteri, head of distribution at WisdomTree, explained the advantage of this type of ETP is that: “Investors can be assured that each ETP is backed by an entitlement to high-quality, securely stored physical metal.”
Instead, with a synthetic gold ETF, such as ETFS Gold, the money is invested in swaps and backed by collateral (usually government bonds), which in the unlikely event of a swap counterparty default would be liquidated and returned to the investor.
This means that a synthetic product carries counterparty risk as well as extra costs.
Adam Laird, head of ETF strategy for Northern Europe at Lyxor, warned: “There is an extra cost with synthetic [products] – the cost of trading the futures derivatives is not included in the fund’s fee and you might find that it lags the gold price the longer you hold it.”
Both Laird and Spiteri take trouble to emphasise that it is very unlikely this option would be the preferred choice for a retail investor, given the extra costs and complexity of the product.
Hector McNeil, co-CEO at HANetf, explained the only small advantage of holding a synthetic gold ETF could come from the potential differential between the raw and collateral yield, which together with the change in spot price make up the overall return of these products.
However, he also agreed that choosing a physical product makes more sense for gold exposure.
Fund ideas – The two most popular gold ETPs among Hargreaves Lansdown’s clients are the ETFS Metal Securities Physical Gold, with an ongoing charge of 0.39% and an indicative spread of 0.04%, and iShares Physical Gold ETC, with an OCF of 0.25% and an indicative spread of 0.08%.
How do ETPs track the gold price?
In terms of return, physically-backed ETPs attempt to provide investors with a return equivalent to the movements in the gold spot price, minus management and storage fees.
The majority of ETPs track the LBMA London Gold Market Fixing Price index. The LBMA fixes as reference price twice a day, though gold trading is a continuous 24-hour market.
Some ETP providers track the morning price and some the afternoon fixture, but McNeil said this is arbitrary and makes no difference to the returns or the accuracy with which the product tracks the gold price.
Of the 42 gold ETFs reviewed by TrackInsight, the majority track this index or a currency-hedged variation.
According to TrackInsight, the total expense ratios (TERs) for the 15 ETPs that track the LBMA London Gold Market Fixing Price PM index vary from 0.17% to 0.5% (with currency-hedged products being more expensive).
The one-year tracking difference on this selection of products varies from 0.4% to 0.2% on the majority of these funds, as of the end of November 2018.
IG’s Smith said the bid-ask spread on gold ETPs should be around 0.05% to 0.1%, which means a “round trip buy/sell of £1,000 would cost £1”.
He added: “Try and buy gold ETFs in your home currency, pounds rather than dollars, to avoid paying additional foreign
“It makes no difference whether your gold ETF is sterling, dollar or euro denominated – gold is gold.”