A Better Mousetrap for Gold

A recurring theme in my writing and in my portfolio management is to follow and explore new products as possible better mousetraps for existing stocks or funds I own. PowerShares may have come up with a better mousetrap for capturing the markets in gold, silver and oil.

Investors who use streetTRACKS Gold Trust(GLD) or iShares Comex Gold Trust(IAU) for either speculation or diversification may want to open themselves to the possibility that Deutsche Bank's PowerShares DB Gold(DGL) could be an improvement on gold investing or trading.

DGL has some major structural differences from GLD and IAU. The latter two hold the physical metal in vaults. As the funds draw new assets, they buy more metal, and then store that as well. Some investors are comforted by the fact that the funds are backed by gold bars.

DGL owns no gold. It creates the exposure through the futures market, so most of its assets are in Treasury bills, which pay interest. Based on the history of interest rates, it's a reasonable bet that DGL's expenses will always be covered by the interest income and that there will be at least a little left over for the fund to pay to its shareholders.

That's not to say that DGL should be thought of as an income producer. But the potential for some interest exists, whereas GLD and IAU won't pay anything, and in fact have to sell some gold to cover their respective 0.40% expense ratios.

The biggest potential downside with DGL is the consequence of contango: rolling to a new futures contract that is more expensive than the one expiring. Deutsche Bank believes it has mitigated most of the risk by employing what it calls Optimum Yield, which allows it to select the contract that it believes is most favorable to roll forward to within the next 13 months.

This guarantees nothing. And although contango tends to be less of an issue in the gold market than in the energy market, I have seen contango cause some nasty surprises for oil ETF holders. Contango is less of an issue in the gold market now, but that doesn't mean it will always be so in the future. Obviously, GLD and IAU don't have to deal with this issue because they don't rely on the futures market.

So far, DGL tracks GLD exactly (in percentage moves). It's too early in DGL's life span to know whether this will continue. It's also possible that DGL could outperform due to backwardation (the opposite condition of contango). But if the prices do continue to track each other in this manner, the interest DGL earns means it will outperform the other two funds.