Bigger Isn't Always Better - IndexUniverse.com

Going For The Gold
By Lara Crigger
In August, the SPDR Gold Trust (NYSE
Arca: GLD) briefly became the world’s
largest exchange-traded fund, with $76
billion in AUM, surpassing the longreigning
champ, the SPDR S&P 500 ETF
(NYSE Arca: SPY), with $74 billion.
While GLD’s dominance was shortlived—SPY
quickly reclaimed the top
seat—the gold market bull trend hasn’t
been. Investors want gold, and GLD’s success
is just one piece. What’s the best way
to gain exposure to the yellow metal?
Getting Physical
The most popular way to play gold is
through ETFs that just buy gold.
Physically backed funds, including
GLD and its competitors, hold one asset:
gold bars. These funds store standard
London good delivery bars in secure
vaults located in major gold markets
such as London or New York. They all
tightly reflect gold’s daily price performance,
minus expenses (Figure 1).
They are not, however, identical. For
starters, the funds differ on costs. IAU has
an expense ratio of just 25 basis points,
while GLD, SGOL and AGOL each charge
39-40 bps in fees. While the difference
isn’t jaw-dropping, it should ensure that
IAU outperforms the other physically
backed ETFs over the long term.
Another distinguishing factor is
where their gold is stored. GLD stores
its gold in London, the world’s leading
market for gold; IAU vaults in London,
New York and Toronto; SGOL stores its
bullion in Switzerland; and AGOL uses
vaults in Singapore.
The theory here is this: Should the
U.S. or British governments decide
for some reason to prohibit private
gold ownership, only holdings outside
those countries would remain safe.
While there is some historical precedent
for this (the U.S. confiscated gold
holdings in 1933), it’s clearly a tail risk
for gold holders, and not one that’s
free to hedge. The trade-off is liquidity:
AGOL in particular has a noted lack
of liquidity, and while SGOL trades at
tight spreads, it’s less robustly liquid
than IAU or GLD.
One downside shared equally by all
physically backed ETFs is tax treatment.
The IRS taxes their long-term capital gains
at the collectibles rate of 28 percent.
That’s substantially higher than the 15
percent rate that applies to most ETFs.
The Futures Fix
Gold investors can dodge the collectibles
tax through futures-based ETPs. Two
currently exist on U.S. exchanges: the
PowerShares DB Gold Fund (NYSE Arca:
DGL) and the UBS E-TRACS CMCI Gold
Total Return ETN (NYSE Arca: UBG).
DGL is the big player: In the four years
since its inception, DGL has amassed $342
million in assets under management; UBG
has just $7.3 million (Figure 2).
Because DGL and UBG track futures
contracts, both funds are subject to
backwardation and contango, where farther-out
contracts on the curve are either
less or more expensive than near-term
contracts. Gold futures tend to trade in a
persistent, small contango, which creates
a low-grade drag on returns.
DGL at least follows a methodology
that, come roll, selects whichever contract
over the next 13 months offers the highest
positive roll yield—or, barring that,
the lowest negative yield. UBG holds five
contracts of constant maturities, ranging
from three months out to three years, in
an attempt to avoid contango.
DGL’s fancier methodology comes at
a price: UBG costs just 30 basis points
per year, while DGL charges 75 basis
points. However, as an ETN, UBG also
inherently carries some credit risk, which
could discourage some investors.
Taxwise, UBG is the more advantageous
of the two: According to current
precedent, long-term holdings in
UBG are taxed at 15 percent and no
taxes are due until you sell the fund.
By contrast, futures-holding ETFs like
DGL are marked-to-market each year,
meaning investors will owe taxes on
any gains at year-end even if they
don’t sell the fund. Gains are taxed at
the 60/40 blended tax rate common
to all futures investments.
The Equity Approach
Another tax approach is to skip gold exposure
altogether. Several ETFs track the
stocks of gold miners and producers, led
Figure 1
Physical Gold ETFs
FUND
TICKER
6-MONTH
RETURN
(%)
YTD
RETURN
(%)
1-YEAR
RETURN
BULLION
HOLDINGS
(TONNES)
AUM
($,M)
EXP
RATIO
INCEPTION
DATE
SPDR Gold GLD 26.31 25.80 44.21 1,230.80 75,302.40 0.40 11/12/04
iShares Gold Trust IAU 26.32 25.83 44.31 147.44 8,201.22 0.25 1/21/05
ETFS Physical Swiss Gold SGOL 26.24 25.72 44.10 29.13 1,559.92 0.39 9/9/09
ETFS Physical Asian Gold AGOL 26.35 N/A N/A 1.13 65.00 0.39 1/14/11
Source: Bloomberg. Data as of 09/01/2011
4 ETFR • October 2011