What you need to consider when buying a gold ETF

For starters, decide whether you’re more concerned about the cost or liquidity.

  • By Simon Constable,
  • The Wall Street Journal
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Gold is back in fashion on Wall Street. But unlike years ago, exchange-traded-fund investors wanting to bet on the metal now face an array of choices.

Some ETFs own bars of bullion, while others invest in gold futures contracts that give buyers the right to buy the metal at a certain price on a certain date. There also are funds that use a combination of debt and derivatives to track gold’s price.

There are pros and cons to each approach, and picking the right fund can be challenging for those wanting to add gold exposure to their portfolios.

The price of gold essentially moved sideways from 2014 through the early part of this year, failing to breach $1,380 a troy ounce. But with trillions of dollars of debt around the world now offering sharply lower—or negative—yields, traders caught the bullion bug, sending the price of gold soaring above $1,540 in September, a 20% jump from $1,270 in early May, according to data from the London Bullion Market Association. An ounce currently fetches about $1,500.

Here are some things fund investors should consider before picking a gold ETF.

1. Cost or liquidity?

Investors first need to decide which is more important to them: a fund’s annual expenses or its trading volume.

“Essentially either the highest priority is liquidity, or it is annual costs,” says Todd Rosenbluth, head of ETF and mutual-fund research at New York-based CFRA Research.

Liquidity usually refers to the volume of shares traded on a given day. Liquidity is particularly important for investors seeking to put large amounts of money to work. They want to be sure that a trade of a reasonable size won’t move the fund’s price in the wrong direction. Large-scale sales (or purchases) of ETFs with relatively low liquidity are more likely to push the price down (or up), hurting returns. The cost of such adverse price moves could vastly outweigh a fund’s expenses, experts say.

PFor investors focused on liquidity, Mr. Rosenbluth points to SPDR Gold Shares (GLD), which launched in November 2004 and was the first bullion-backed ETF. About 12.3 million shares of GLD change hands each day on average, which should be enough to give most well-heeled investors the liquidity they want, he says. The annual expense ratio is 0.4%, which is higher than many other bullion-backed ETFs.

For a long time, GLD was the primary choice for investors wanting an ETF backed by solid metal. But competition has changed the landscape.

“In the last couple of years there have been a handful of ETFs that have come out that have significantly undercut [GLD’s] price,” says Mr. Rosenbluth. “They have been gaining assets, and the liquidity has been improving.”

Mr. Rosenbluth points to two relatively new bullion-backed products as worthy of consideration. GraniteShares Gold Trust (BAR), which launched in August 2017, has annual expenses of 0.17% and trades an average of 155,000 shares a day. There also is State Street Corp.’s SPDR Gold MiniShares (GLDM), which launched in June 2018. It has annual expenses of 0.18% and average daily trading volume of 1.3 million shares.

Other bullion-backed ETFs include iShares Gold Trust (IAU), Aberdeen Standard Physical Swiss Gold Shares (SGOL), VanEck Merk Gold Trust (OUNZ) and Perth Mint Physical Gold (AAAU)

Of course, bullion-backed ETFs are only part of the story. Some ETFs hold gold futures, such as Invesco DB Gold Fund (DGL). It has hefty expenses of 0.75% and a modest daily trading volume of 27,000 shares. However, the extra cost is more than offset by a 1.3% yield. By comparison, bullion-backed ETFs typically yield zero.

2. Stable sponsor?

Another important consideration for investors weighing gold ETFs is the stability of the fund’s sponsor. Put another way, is the company behind the ETF robust enough that investors don’t have to worry about the fund folding?

Each year around 100 ETFs shut down, says Mr. Rosenbluth. Typically, the ETFs that go under have less than $100 million in assets. “Investors use the $100 million threshold to judge whether a fund is commercially viable,” he says.

So far, no gold ETF has disappeared, Mr. Rosenbluth says. But that doesn’t mean it couldn’t happen.

“You have to look at the firm’s history and the firm’s product portfolio,” says Ben Johnson, director of global ETF research at Morningstar in Chicago. In other words, is the fund sponsor run well enough to sustain a new ETF while it gets established?

Companies such as State Street and Invesco are clearly well-established, he says.

And although it is smaller, GraniteShares looks solid too, he says. “It has direct backing from Bain Capital,” Mr. Johnson says, and its gold ETF has $600 million in assets.

3. Avoid leverage and shorting

While the funds mentioned above are relatively simple, other gold ETFs complicate the matter by using derivatives to juice returns.

These ETFs often use phrases such as “double-long” or “inverse” in their titles. While they might seem attractive at first glance, most individual investors would do well to avoid them, says Richard M. Rosso, director of financial planning at Houston-based wealth-management firm RIA Advisors. Only experienced investors with a lot of self-discipline and a predetermined plan for when to buy and sell should consider leveraged investments, he says, and even then they should own them only for short-term trades.

“It’s really like putting a nuclear weapon in the hands of someone,” says Mr. Rosso.

One example is the DB Gold Double Long ETN (DGP). It is designed to move in value twice as much as the price of gold each day and is considered a leveraged investment. There are also products designed to go up in value when the price of gold goes down.

These types of funds are inappropriate for individual investors for two reasons, Mr. Rosso says.

First, research suggests that for most people, investment losses feel worse than gains feel good. And because leveraged funds jump around far more than other gold ETFs, sooner or later investors are likely to see big losses. “With this type of product, you’ll multiply your distress,” he says. In September, for example, investors in unleveraged gold funds lost around 4%, while those in the DB Gold Double Long fund were down more than 9%, according to Yahoo data.

Another problem with leveraged funds is something called “decay.” This refers to the reduced performance of leveraged funds over time. So while funds such as DB Gold Double Long might deliver two times the return of gold at times, they don’t always work the way an investor might expect based on the fund name.

For example, over the two years through Oct. 1, the DB fund returned approximately 18%, while SPDR Gold Shares, which tracks the price of gold, gained 15%.

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