By Samuel Lee
Gold is the "Armageddon currency." Its holders are naturally
concerned about the rules of the game being changed on them--fraud,
government expropriation, and, for the extremist fringe, the
collapse of social order, are not inconceivable scenarios. While
some gold bugs like to be able to fondle their bullion, the
cost-conscious must make do with paper ownership, via
exchange-traded funds. However, the logic of gold fights against
the attenuated ownership rights ETFs provide, so ETF firms plaster
attestations of the safety of their gold all over their websites:
inspectorate certificates, gold bar lists, pictures of the gold in
the vaults, and so forth. ETFS Physical Swiss Gold Shares (
) goes even further. Its gold is held in subcustodian UBS' (
) Zurich vaults.
Switzerland's centuries-long history as a haven for capital
appeals to investors worried about the safety of claims on gold
held in New York or London vaults by the other big gold ETFs. That
added safety is, for the most part, illusory. The ETF's shares are
issued in the United States, its primary custodian is JPMorgan
) (the same custodian as iShares Gold Trust (
)), and the independent audits are conducted by Inspectorate
International Ltd., the same firm that inspects bullion held for
SPDR Gold Shares (
) and IAU. They all rely on American rule of law to enforce
ownership claims. The real reason to diversify geographically is
concerns about the physical safety of gold held in New York or
London. Let's not go into when that might be a good idea.
Gimmickry aside, SGOL stands on its own as a reasonable way to
get gold exposure. It has done a good job of tracking the spot
price of gold, is fairly liquid, and charges a competitive fee.
But before hopping on the bandwagon, investors should strongly
consider gold's proper role as an investment. Gold, like all
commodities, earns nothing itself, and its theoretical long-run
expected return is zero. Its record-busting performance has
attracted a lot of speculators and performance-chasers. However,
speculation is a zero-sum game that usually profits a small slice
of investors--the lucky and the clever--leaving the less lucky and
less clever holding the bag. Investors should look beyond its
speculative uses: Gold is a decent inflation/currency debasement
hedge and uncorrelated with stocks and bonds, so it can be a good
It's worth critically examining gold's purported diversification
benefits. From 1973 to 2010, gold's yearly performance had a 0.49
correlation with yearly inflation. Its yearly performance had a
0.43 correlation with three-year forward inflation. At that level,
gold's movements predict about 18.5% of the variation in future
inflation--not quite a slam-dunk as a pure inflation hedge. Over
the same period, gold had a negative 0.33 correlation with the
dollar's value versus a basket of major currencies. There are far
more efficient ways to hedge against such risks, such as holding
Treasury Inflation-Protected Securities or foreign currency.
However, it doesn't correlate much with stocks or bonds, so it's
potentially a good diversifier. Gold is more like all-purpose
disaster insurance, useful for reasons other than narrow bets on
currency debasement or inflation.
It's hard to value gold in the current environment. Gold doesn't
produce an income stream or come with a set of financial
statements. One logical way to value gold is to divide the world
money supply by the total gold stock. By such measures, gold is
quickly approaching its historical mean. Another factor to consider
is momentum. Gold's price exhibits a lot of trendiness, perhaps
owing to its hard-to-value nature and the fact that some of its
biggest buyers, central banks, are not motivated by economic
profit. Its yearly performance is moderately correlated with its
past year's performance.
There are substantial risks to the shiny metal as it approaches
its historical mean. Until a short time ago, most of it was made
into jewelry, with a small slice for industrial uses. Over the past
decade, the demand mix has changed toward investment, starting at
4% of demand in 2000 and growing to 38% by 2009, according to the
GFMS Gold Survey 2010. Investors' growing appetite for it coincided
with 17.7% annualized returns from 2001 to 2010. What could happen
when no one wants gold anymore? We need only look back to the 1990s
for some perspective, when gold lost 4% annualized from 1988 to
2000--far worse than the disastrous "lost decade" for U.S. stocks.
The money supply's growth could slow down or even shrink when
central banks begin mopping up excess liquidity. Though a ways off,
such a readjustment will probably brutalize gold prices. Investors
who buy gold as insurance should understand that insurance policies
aren't supposed to make you rich.
Each share represents about 0.1 ounce of gold bullion, less
accumulated fees. The gold is held by UBS AG in Switzerland. ETF
Securities publishes a daily list of bar numbers and posts audit
results on its website. Like the other big gold ETFs, this fund is
structured as a grantor trust, which acts as a pass-through vehicle
for the underlying gold.
The fund charges 0.39% annually. It will sell off gold to pay its
expenses, so each share will hold a tiny bit less gold over time.
The fund isn't as liquid as the bigger gold ETFs, so trading in and
out will take an additional bite of perhaps a few basis points.
The two biggest gold ETFs are SPDR Gold Shares (
) and iShares Gold Trust (
), also grantor trusts. GLD is the biggest, most-liquid gold ETF
and charges only 0.40% a year. IAU is slightly less liquid, but
it's the cost champion at 0.25% and therefore our favorite.
Morningstar licenses its indexes to certain ETF and ETN providers,
including BlackRock, Invesco, Merrill Lynch, Northern Trust, and
Scottrade for use in exchange-traded funds and notes. These ETFs
and ETNs are not sponsored, issued, or sold by Morningstar.
Morningstar does not make any representation regarding the
advisability of investing in ETFs or ETNs that are based on
ETF Deathwatch For October 2012: The Zombie ETFs