OK, OK, I know. You took one look at my title and asked: “Why would I even want to consider adding a gold-backed ETF to my portfolio?” But then curiosity got the better of you and you clicked on the article just to see what it was all about. Am I close to correct so far?
If this is how you felt, or feel, please know that I felt exactly the same way until about two years ago. I'd had very little interest in looking seriously at gold. If asked why, I would likely have featured Warren Buffett's view of gold, as evidenced by the following quote:
[Gold] gets dug out of the ground in Africa, or someplace. Then we melt it down, dig another hole, bury it again, and pay people to stand around guarding it. It has no utility.
Two years ago, however, I offered my take on the perfect portfolio for the next 10 years. In response, several readers suggested that I consider at least a modest allocation to gold in my proposed portfolio. And so, over approximately the next two months, I read, and learned. In turn, that led to writing several articles on the topic. At the end of this article, I will link to some of these, as further reading for any who are interested.
To keep this article from becoming as long as War and Peace, however, let me offer just a brief answer to the question I proposed in the first paragraph, and then we’ll get into the recommended ETFs.
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Why Would I Consider Gold-Backed ETFs?
In brief, the answer to that question is something known as correlation. Put simply, it means that various asset classes either move in very similar patterns (high correlation) or very different patterns (low correlation). As it happens, gold has a very low correlation to several other asset classes you likely hold in your portfolio, so it can help ‘smooth out the ride’ of your investment returns, so to speak.
It has been said, ‘A picture is worth a thousand words.’ So, here are 4 pictures, and just a few words.
First, from a paper entitled The Golden Dilemma, by Claude B. Erb and Campbell R. Harvey.
Over the period from 1975-2012, quadrant 3 represents the percentage of the time in which both the S&P 500 and gold fell at the same time. As can be seen, that represents 17% of all observations. The flip side is that, in 83% of the covered periods, gold served a valuable function as a hedge.
Next, from a recent case study from State Street Global Advisors (SSGA).
In Figure 1, they display the results when one starts with an already-diversified portfolio, and then introduce an allocation to gold of 2%, 5%, and 10%, subtracting small percentages from the other components to do so. They propose that the investment returns remain quite similar, but with less volatility. As an aside, Figure 2 provides a more granular breakdown of Figure 1.
Now, State Street just happens to be the marketing advisors for a couple of the gold-backed ETFs that will be featured in this article. So, to play devil’s advocate, let’s take the view that we are slightly cynical about their “results” and would like to verify them independently.
Happily, we can use a tool known as Portfolio Visualizer as a second reference. Feel free to click this link if you would like to see the results for yourself.
This backtest covers the period from January, 1987 to the date this article is written; some 34 years. As seen in the next screen shot, I start with a 60/40 portfolio comprised of the Total US Stock and Bond markets. I then take 5% from each to incorporate a 10% weighting in gold. As an aside, I also show the results with a 100% allocation to US Stocks over that same period.
Next, the results.
Of course, this simple 60/40 portfolio is not as comprehensive as the one State Street put together. However, the key takeaway is that the basic result is the same. Our 10% allocation to gold, while lowering the total return just slightly, significantly decreased the volatility, as represented by the Stdev, Worst Year, and Max Drawdown columns.
With that brief background, it’s time to look at our 6 ETFs!
In this section, I will feature two different ETFs from the same family, and briefly explain both their similarities and differences.
- NOTE: I will delve into a little more explanatory detail on these two than subsequent ETFs mentioned in the article. This is not because I have any preference for these ETFs, but for brevity it will be easier to lay a basic groundwork once, and then simply feature comparative differences of the other ETFs.
I might well refer to SPDR Gold Shares (GLD) as the "gold standard" (pun completely intended) in its segment. With an inception date of 11/18/2004, it is the first gold-backed ETF launched in the United States.
GLD’s prospectus explains that “a basket equals a block of 100,000 shares” and further that “the initial amount of gold . . . was 10,000 ounces per basket.” That quickly tells you that one share represents approximately 1/10 of an ounce of physical gold. In one of my “further reading” links, I explore the mechanics of how gold-backed ETFs work, and why I used the word “approximately” in that last sentence.
The gold custodian is HSBC Bank plc, and the physical gold is stored in the custodian’s vault in London. The Net Asset Value (NAV) of the Trust is calculated daily, on the basis of the price of an ounce of gold at the London Bullion Market Association (LBMA) Gold Price for the day.
The Trust’s only recurring fixed expense is the Sponsor’s fee, which accrues daily at an annual rate equal to 0.40% of the daily NAV. In exchange, the Sponsor covers all ordinary fees and expenses of the Trust, including the Trustee, the Custodian (responsible for the custody of the Trust’s gold bars), and other fees including printing and mailing costs, legal and audit fees, and the like.
What about that second ETF, SPDR Gold MiniShares Trust (GLDM)? In a previous article here on TheStreet.com, my fellow author David Dierking featured the differences between QQQ and QQQM, two ETFs that track the same Nasdaq 100 index.
Essentially, we have a similar situation with GLDM. As time went on, competing gold-backed ETFs were developed, and several significantly undercut GLD’s expense ratio of .40%. To compete, SSGA came up with a second offering. GLDM’s expense ratio of .18% brings it more in line with some of the newer upstarts. The gold custodian is ICBC Standard Bank Plc, and the physical gold is stored in the custodian’s vault in London.
As you will discover if you review GLDM’s prospectus, each 100,000 share basket represents approximately 1/100 of an ounce of physical gold. As a result, its share price is roughly 1/10th of GLD, allowing for easier trading in even small accounts.
So, why would anyone invest in GLD, with its .40% expense ratio, when you can own GLDM for .18%? In two words; trading spread. GLD averages $1.52 billion in daily trading volume, with an extremely tight trading spread of .01%. GLDM, on the other hand, averages a comparatively modest $41.91 million in daily trading volume, leading to a trading spread of .05%.
Can you see how an active trader might well prefer GLD, even with it’s higher expense ratio? At .05% a pop, trading GLDM would chew up that difference very quickly. On the other hand, the buy-and-hold investor who desires a long-term allocation to gold may likely select GLDM.
iShares Gold Trust (IAU)
iShares Gold Trust (IAU) comes to us from the BlackRock family of ETFs.
With an inception date of 1/21/2005, IAU has a track record that goes back almost as far as GLD. At .25%, IAU’s expense ratio is not quite as low as some of its competitors, including those featured in this article. However, its size, track record, and a couple of unique items I will feature below make it, for my money, worth consideration.
IAU’s custodian is the London branch of JPMorgan Chase. According to its published materials, it maintains vault locations in London, New York, and Toronto. As of its 7/7/2021 gold bar list, however, it only shows holdings in the London and New York vaults, with roughly 85.8% of its gold in London and the remaining 14.2% in New York.
In summary, in terms of differentiations with the GLD/GLDM products, IAU has a subsidiary of BlackRock (BLK) as its sponsor as well as a different custodian. Finally, its gold bullion is stored in two different physical locations.
GraniteShares Gold Trust (BAR)
In August 2017, sporting an expense ratio of .20%, GraniteShares Gold Trust (BAR) burst on the market as the cheapest gold-backed ETF, half the expense ratio of venerable GLD.
To compete, SPDR launched the SPDR Gold MiniShares Trust (GLDM) with an expense ratio of just .18%. Not to be outdone, GraniteShares dropped the fees for BAR to .17% in October 2018, and that's where we stand today. In that short time, BAR has proved to be a popular competitive offering, amassing an AUM of $1.033 billion as of the time of this writing.
In terms of structure, while BAR is far smaller than GLD and GLDM, all other operational aspects are the same. It too is a Grantor Trust, meaning that the gold held in its vault is not traded, leased or loaned under any circumstances. Similar to GLDM, the gold custodian is ICBC Standard Bank Plc, and the physical gold is stored in the custodian’s vault in London. And it has the same physical audits, conducted by Bureau Veritas.
Both in terms of expense ratio and trading spread (.05%), BAR is perhaps most directly competitive with GLDM.
Aberdeen Standard Physical Gold Shares ETF (SGOL)
Aberdeen Standard Physical Gold Shares ETF (SGOL) has an inception date of 9/9/2009. However, prior to October 1, 2018, it was known as the ETFS Gold Trust.
The big recent news with respect to SGOL is its expense ratio. Formerly .39%, on December 3, 2018, new sponsor Aberdeen Standard Investments reduced the sponsor fee for SGOL to .17%, matching BAR for the lowest expense ratio for a gold-backed ETF.
Here is perhaps the biggest reason you might select SGOL. Its gold is almost equally split between its vaults in London and Zurich, Switzerland. In its prospectus, SGOL comments on this differentiator this way.
“The geographic and political considerations of owning gold in Zurich may appeal to certain investors.”
That’s a very understated way of saying that, for a variety of reasons, gold stored in Zurich is probably about as safe as anywhere on earth, due to Switzerland’s long history of both political neutrality and financial privacy.
Sprott Physical Gold Trust (PHYS)
Sprott Physical Gold Trust (PHYS ) deserves a place in this article, and your consideration, mainly because of one key difference as compared to all other ETFs featured here.
If you decide to do any extensive reading on the topic, you will quickly find that critics of traditional gold-backed ETFs often refer to them somewhat dismissively (even derisively?) as nothing more than 'paper gold' since you are never, as a practical matter, able to get your hands on physical gold.
Here, then, is perhaps the single biggest area in which PHYS differentiates itself. Here's the key paragraph in the prospectus.
Subject to the terms of the Trust Agreement, trust units may be redeemed at the option of a unitholder for physical gold bullion in any month. Trust units redeemed for physical gold bullion will be entitled to a redemption price equal to 100% of the NAV of the redeemed trust units on the last day of the month on which NYSE Arca is open for trading for the month in which the redemption request is processed. (Bold mine, for emphasis)
In short, you can redeem units for physical gold and have this shipped to the location of your choice via armoured (yep, spelled the Canadian way in the prospectus) transportation service carrier.
PHYS carries an expense ratio of .42%, the highest of our group. Further, the minimum redemption amount is "one London Good Delivery bar." Such a bar must weigh between 350 and 430 troy ounces, and most bars fall between 390 and 410 ounces. Just multiply that by the current per-ounce price of gold and you will quickly find that the “physical redemption” option is really only meaningful to those of us blessed with, well, an enviable amount of assets. Still, if you are fortunate enough to be in that club, PHYS is certainly worth a look.
Even though I tried to keep things condensed, this article ended up being fairly lengthy. It’s OK, I am hoping it will serve as a nice roadmap to get you started when it comes to the world of gold-backed ETFs.
If you want to dig in even deeper, here are some additional links. For example, how, exactly, do gold-backed ETFs work? Like any other ETF, they have expenses that must be paid. How do they do so?
And what about my reference to critics dismissing these ETFs as ‘paper gold’? A couple of articles below discuss something I refer to as the ‘Bar ZJ6752’ fiasco. As the saying goes, ‘forewarned is forearmed,’ and I hope to do that for you as you make your personal investment decisions.
Whatever your final decisions, I wish you . . .
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