Sponsored Content - About 20 years ago, gold exchange traded funds (ETFs) made their appearance in financial markets. After two decades, they are still largely misunderstood. Let’s see if we can clear up some of the confusion, says Rich Checkan, president & COO, Asset Strategies International.
I remember the launch of gold ETFs like it was yesterday. Investors were curious about this new investment vehicle. Brokerage houses were excited to offer “gold.” Gold dealers, in general, were not happy to see a new form of competition.
As a gold dealer, Asset Strategies International (ASI) was in the minority. We did not see gold ETFs as a threat. Rather, we saw this as an opportunity for the banks and brokerages—who had quite deep pockets—to help us tell the particularly critical story of the importance of gold ownership.
In the end, I’m sure ETFs took some business away from gold dealers, but not a lot. The reputable dealers, like ASI, are still alive and kicking today. I would guess that many of the investors who bought gold ETFs were probably not going to buy physical gold anyway. And…the gold price absolutely benefitted from the increased awareness and consumption throughout the bull run ending in 2011.
Not the Same
The first thing to understand about gold ETFs is they are not the same as owning physical gold.
When you own a gold ETF, you own shares in a fund whose fund manager’s job is to mimic the gold price. The fund manager does so by buying and selling gold to cover the buying and selling of ETF shares by investors.
However, this is not an exact science—which is why the share price of the fund is rarely a mirror image of the gold spot price.
Consider the SPDR Gold Trust (GLD). The GLD share price is supposed to be one-tenth of the spot price of gold. Yet, it virtually never is. That’s because the fund manager has something to manage here.
Let’s say investors are buying and selling GLD shares all day. The net of all that buying and selling comes out to 50 ounces of gold that the fund manager must buy to meet the demand.
The fund manager cannot do it.
The bullion banks have a minimum purchase (or sale) of 100 ounces. So, the fund manager is faced with a decision…buy 100 ounces and have a long position of 50 extra ounces or not buy and have a short position of 50 ounces.
The fund manager makes that decision based on their best guess as to where the market will go tomorrow. Sometimes they are right. Sometimes they are wrong. How well they mimic the gold price depends on the success rate.
With physical gold, if you buy an ounce, you own an ounce based upon the spot price of gold at the time.
The second thing to understand about gold ETFs is that, for the vast majority of them, you own NO gold. You simply own shares in the fund. That means you cannot take delivery of your gold either.
With physical gold, you own and take delivery of the physical bars or coins. Of course, that adds extra costs to your ownership in many cases. You pay a premium to fabricate the raw gold into bars or coins. You further pay to have it delivered to you or to have it stored for you.
These fees tend to out-weigh the fund management and brokerage costs of a gold ETF…but not in every case. Unique programs like the Perth Mint Certificate Program (PMCP) and the Perth Mint Distributor Depository Online (PMDDO) can rival or beat the up-front costs of a gold ETF with NO ongoing storage costs.
This is where gold ETFs have made a significant difference in the gold market over the past 20 years.
Prior to the advent of gold ETFs, gold was the domain of strong-handed investors. By that I mean those who bought gold tended to hold onto it for the long term. That was largely due to the fact that it was a small nuisance to sell it.
You had to ship your gold to a dealer, have them verify it, then wait for payment. There are ways to speed up virtually every aspect of that process nowadays, but the typical physical gold buyer tends to hold onto their metal for the long haul.
There are strong-handed gold ETF buyers as well, but there are also a lot more speculators.
Because it is quick and easy to jump in and out of gold ETF positions, speculators are attracted to this form of ownership. But there is another phenomenon associated with gold ETFs…the distress sale.
In our current environment, we are seeing this a lot. The distress sale, as I call it, refers to those leveraged investors in the equities markets who need to make a margin call.
Those investors borrowed money against their principal to place bigger bets in the casino known as the stock market. As the Dow Jones Industrial Average, the S&P 500, and the Nasdaq have fallen thus far this year, the underlying value of the equities has fallen below the value of the loan. In such an instance, the investor must inject cash into the account or risk default…losing everything.
In most portfolios, the most liquid asset they have is also their best store of purchasing power…gold. As a result, they sell gold ETFs to raise the cash to meet their margin calls.
We have seen that every time the equities markets fall. We are seeing it again now.
Volatility is part of the gold market since the emergence of gold ETFs.
Not a Zero-Sum Game
To me, the most important difference between physical gold and gold ETFs is the counterparty risk.
For millennia, gold has been a liquid store of purchasing power with no management required. If you own it, you have full value and full control.
Gold ETFs bring in significant counterparty risk in the form of…the fund manager, the depository, the trust, etc.
There are clear differences between the two methods of participating in the gold market. Both have their advantages. Both have their challenges.
Holding both in a portfolio is not a bad thing. Use them both for their strengths to accomplish your goals.
But when it comes to wealth insurance, insist on physical gold. It is the only way to ensure you can meet the financial crisis it was designed to protect your wealth against.
Keep gold ETFs as part of your equities allocation. Keep physical gold for your golden anchor.
That’s how you Keep What’s Yours for both personal and IRA funds!
Call Asset Strategies International at 800-831-0007 or send them an email to set-up a consultation…now… today!
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