Gold ETFs tend to be a go-to investment for investors when they’re worried about inflation or suspect that financial markets are about to collapse. But when investors are feeling good about the markets, gold attracts little interest. This was seen as confidence resumed in the wake of the financial crisis, when gold slumped from over $1,800 an ounce to below $1,000.
To some investors, gold is an insurance policy for times of crisis. It trades a little like currency, a throw-back to when dollars were backed by gold. And because gold is beyond the reach of governments, its price can’t be manipulated by lowering interest rates or printing money.
There are 2 main ways to invest in gold: by buying physical gold such as gold bars or jewellery, or through ETFs or futures. ETFs have become an increasingly popular option, allowing investors to take a view on gold at low cost and without the problems of storage costs or security.
Gold ETFs have been around for some time. The first one was developed by ETF Securities and launched on the Australian Securities Exchange (ASX) in 2003. Gold ETFs have proved popular with investors and are now an increasing influence on the price of gold.
This year, for example, the SPDR Gold Shares, was a major buyer of gold, with its gold stores reaching 1,258 tonnes, held in a London vault.
The key advantage to gold ETFs is that you don’t need a huge amount of capital to invest. They are traded readily during market hours on an exchange, just like shares. Pricing is transparent and it is relatively cheap to invest – you pay a broker’s fee and an annual management charge to the ETF provider.
There are several different types of gold ETFs:
The simplest gold ETF is “physically-backed,” which means that gold will be bought and stored in a vault – this is what backs the fund’s price. If you buy a stock of the fund then, theoretically, you own a little piece of that bullion. This is the most popular option and the largest ETFs on the market are physically-backed. These ETFs track the price of gold closely.
Gold ETFs can also track gold futures. These may deviate from the gold price because of differences between the spot price of gold and futures prices (called ‘backwardation’ or ‘contango’). Backwardation occurs when the spot price is higher than the near future contract. Contango is more common – when the spot price is lower than the closest future contact.
There are also ETFs that track the performance of a bunch of gold mining companies. While these company shares are impacted by the gold price, there will be other factors at work, such as the success of the company itself, the price to mine gold, labour costs and other considerations.
There are a number of less common ETFs. Inverse or “short” gold ETFs aim to move in the opposite direction to the market price of bullion. If an investor put $5,000 in inverse gold ETF shares and the gold price dropped 5%, the value of the shares would increase by $250.
Leveraged gold ETFs increase exposure to the price of gold. A 2x leveraged ETF will double the extent of any price moves. So, if an investor put in $5,000 and the gold price rose 5%, they would receive $500, while a fall of 5% will lose them $500.
Finally, smart beta gold ETFs are a relatively new phenomenon. These are designed to deliver higher returns than a gold shares benchmark. They may tilt exposure towards those companies with higher revenues, or high dividends, for example.
These are the main gold ETFs trading on Canadian and US stock exchanges:
The price of gold is influenced by a number of factors including gold buying by consumers and central banks. There are the key areas that will influence the gold price:
Central bank policies are an important factor in the gold price. Gold tends to do well when interest rates are lower. This is usually because low interest rates come at a time of fear, but also because gold doesn’t pay any kind of income. At times when investors can get a high income from bonds or cash, holding gold has a significant opportunity cost. If an investor is getting 5% from a savings account and nothing from gold, gold exerts a permanent drag on portfolio returns.
Gold does well when investors lose faith in financial assets. Investors care less about high returns and more about preserving what they have. The gold price has done well during the tough months following the pandemic, rising to almost USD $2,000 an ounce. It performed relatively poorly during the benign years of 2010 to 2017 when financial assets were rising and economic growth was expanding. It had been rising ahead of the Great Financial Crash in 2008/9 as investors had grown increasingly concerned about the levels of debt in the economy. It is not a perfect relationship, however, and the gold price will often move before investors have had a chance to buy themselves the insurance policy.
Gold is often used to hedge inflation because, unlike paper money, its supply doesn’t change much year to year. Over time, the purchasing power of gold has stayed relatively constant. Again, the relationship is imperfect and gold won’t always rise at times of high inflation, but there is a correlation.
There is an inverse relationship between the trade-weighted US dollar and the price of gold. The ‘trade-weighted’ price reflects whether the US Dollar is gaining or losing purchasing power compared to its trading partners. The Dollar/Gold relationship used to be exact under the gold standard, but this was abandoned under President Richard Nixon in the 1970s. However, many still see a tendency among investors to buy gold whenever the value of the Dollar falls.
After a long period when central banks sought to move away from gold, more recently emerging market central banks have been significant buyers of gold. China in particular has sought to shore up its gold reserves in recent years. Russia, Turkey, Kazakhstan and Uzbekistan have also been significant buyers of gold in recent years.
Countries do this for a number of reasons: many have large foreign exchange reserves that they need to put to work in financial assets. Many emerging market countries also want to diversify away from the Dollar. This is partly for sound economic reasons, but also because they are keen to break the US dominance of the global financial system.
Gold tends to be a port in a storm. As it is seldom clear when that storm will arrive, many global asset allocators always keep a small holding in gold to act as a defense mechanism. Often when investors think about holding gold, it is too late and the price has already risen.
However, it doesn’t mean that the price of gold is consistent – it is not like cash. It can go through periods of significant volatility at times when everyone sees high global growth or strong fiat currencies. That means it can be an expensive hedge in the good times.
Gold draws mixed opinions from investors. That said, there can be little doubt it has been worth holding during the current pandemic. Lucky holders would have seen a 60%+ gain at a time when other financial assets have struggled.
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