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SPDR Gold Trust: No Longer Really An Alternative Asset Class

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By Morningstar :

By Abraham Bailin

Morningstar's Thesis

Precious metals have been the beneficiaries of consistently bolstered demand for safe haven assets. The level of uncertainty in today's markets only continues to drive interest in gold, as prices soar ever higher.

There are a number of options to consider when planning to build an exposure to gold. Investors may use futures or even gold miners. The most popular recent method, however, is the use of physically backed products. The fund we review here briefly became the largest exchange-traded product on the planet in August, passing even SPDR S&P 500 ( SPY ). Are the masses mad, or has the developed world moved into a permanent state of economic decline? We take this opportunity to review the key drivers of gold's price and evaluate today's most often used access vehicle. The product offers razor-sharp long-term tracking of gold but at a price that overshoots the space's cheapest alternative.

Suitability

Though not the cheapest option, SPDR Gold Shares ( GLD ) is the largest and most liquid physically backed gold offering on the market, and it does its job well. By holding bullion, the fund offers investors the price performance of the spot commodity. GLD's bullion is held in London vaults under the custody of HSBC Bank, ridding investors of the inefficiencies and inconveniences associated with transporting and storing the metal. Each share of GLD represents about one 10th of an ounce of bullion at current market prices, so investors here won't have to worry about long-term tracking issues.

A word of caution: Successfully timing a short-run gold investment is not an easy task. When bullion prices are soaring, it's all too easy to jump on the gilded bandwagon. Gold prices soared in the early 1980s, and many speculative investors poured into the market only to lose their shirts after the price of gold collapsed.

For their asset-class-level benefits, inflationary hedging and diversification, we are in favor of maintaining a modestly sized core commodity exposure up to about 10%. Additionally, that exposure should be split between energy, agricultural, and industrial and precious metals. Given its outstanding tracking, GLD should serve well to those ends. The fund can also be used periodically as a satellite holding by speculators looking to hedge unexpected inflation or currency depreciation. GLD's exposure is as granular as they come, but it serves as a very reliable access vehicle in a traditionally hard-to-tap segment of the market.

Fundamental View

Investing in gold is not necessarily a priority for everyone, but it has some valuable uses in a dollar-based portfolio. Gold is a limited commodity that retains purchasing power even under strong inflationary pressures. On the other hand, increased dollar strength will detract from gold's value as investors are able to buy more metal with each bill. Unlike paper currencies, gold is not at the mercy of government policy. It cannot be easily issued or mined, so its value won't decrease overnight as a currency might if the government were to significantly expand the monetary base. This isn't a trivial point. It is difficult to ignore the long-term inflationary impact of the recent dramatic increase of our monetary base.

In an attempt to avoid a deflationary spiral, the Federal Reserve engaged in successive rounds of economic capital injections called quantitative easing. The broad antideflationary monetary policy played to gold's strength and is certain to have contributed to the metal's rise. The Fed will eventually be forced to mop up this liquidity through higher interest rates, but it isn't the most pressing concern. Bernanke has made it clear that to preserve the stability of our financial markets, he will hold interest rates at historic lows for at least the next couple of years. On this basis, we believe a small position in gold should be considered as an insurance policy.

For their ability to better manage geopolitical, currency, and operation-specific risks, we continue to favor gold-related exchange-traded funds and mutual funds over individual mining company stocks. Gold's primary demand drivers are jewelry consumption and investment, which account for roughly 48% and 39% of gold's total demand, respectively. They can exert opposing price pressures. Welling concerns of a global recessionary period might curb discretionary spending on jewelry, but gold's use as a store of value is likely to offset the trend. All tech and industrial related uses account for a mere 12% of total annual demand for the metal.

Gold's rally has become quite a contentious issue. Gold bugs seem to insist that total debasement of the dollar is assured and that prices have plenty of room to run. While this argument carried substantial merit over the past 10 years, the cost of insuring with gold against such a scenario is a much more expensive proposition today. A comparison to the global Organisation for Economic Co-operation and Development money supply seems to indicate that today's levels put gold in a relatively fair price range compared with its dislocated range in 2001.

click to enlarge

What we can conclude from the figure is that, while global developed money supplies have grown drastically, gold prices have grown in tandem to offset pressures of currency debasement. It also illustrates that gold has risen much faster over the past decade than money supply has. The figure does not, however, indicate that gold prices will necessarily continue their climb to prices at which the metal would be overvalued relative to OECD M1.

The largest risks for gold will be associated with increased market confidence and the dissolution of the inflationary pressures that were provided by growth in the money supply. Under these circumstances, demand for gold as a safe haven asset and inflationary hedge would likely dry up.

Portfolio Construction

Under current tax laws, gains on this investment are taxed as collectibles (same as ordinary income rates), at a maximum of 28%, regardless of an investor's holding period. Despite rumors from conspiracy theorists, this fund actually holds physical gold in vaults to back up its shares. As the time of this writing, more than 40.2 million ounces of gold that are verifiably allocated to this fund's shareholders are stored securely under the streets of London. No additional shares of this fund can be produced by cash or derivatives contracts; authorized participants are issued shares in exchange for physical quantities of gold. The only violation to this process is a three-day waiting period from the time of share creation until the physical gold is delivered. The fund is sponsored by the World Gold Trust Services, LLC, and marketed by State Street Global Advisors, LLC.

Fees

This fund levies a 0.40% expense ratio per year. The fund sells gold held by the trust on an as-needed basis to pay the trust's expenses. As a result, the amount of gold represented by each share will fall marginally over time.

Alternatives

The most direct comparison is iShares Gold Trust ( IAU ). The only structural differences are that IAU represents one 100th of an ounce of gold and charges a lower fee of 0.25% per year, but it has less than one 10th the assets invested. Still, IAU is very large and liquid, and our Morningstar Estimated Holding Cost metrics indicate that IAU is a cheaper access vehicle.

Relative newcomer ETFS Physical Swiss Gold Shares ETF ( SGOL ) also shares a similar structure and is price-competitive with GLD at 0.39% per year, but its assets under management are roughly 2% of GLD's. We doubt the lower fee is sufficient enough to make up for SGOL's lack of liquidity in the eyes of most investors, but those concerned with geographical diversification of bullion vaulting will find SGOL attractive.

Those looking for an equity-based exposure to gold should consider Market Vectors Gold Miners ( GDX ). The fund holds the largest players in the industry and its performance should maintain substantial correlation to gold price movements. The key issues to consider here come on the basis of the fund's equity-specific price drivers. When gold rests near the miners' break even per ounce production price, miners may actually exhibit substantial operational leverage to the underlying commodity. While this circumstance can render outsized gains and losses, at today's lofty price levels, much of that leverage has been squeezed out of the system already.

Disclosure: Morningstar licenses its indexes to certain ETF and ETN providers, including Barclays Global Investors ((BGI)), First Trust, and ELEMENTS, 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 Morningstar indexes.

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The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.


The views and opinions expressed herein are the views and opinions of the author and do not necessarily reflect those of Nasdaq, Inc.

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