gold investor

Judging the Benefit of Gold ETFs

May 17th, 2016 by

There are generally three different viewpoints you will find regarding so-called gold stocks or gold funds:

gold investor1. Gold offers valuable diversity in a portfolio, and gold stocks are a convenient way to do so, possibly with leverage;

2. Gold offers valuable diversity in a portfolio, but gold stocks are not actually capable of doing so in the same way that physical gold does;

3. Nobody should own gold at all except as an “ornament.”

By and large, opinion is fairly evenly distributed between these three camps. Yet you would be hard-pressed to find an investor who doesn’t fall into one of these three categories. So what are the benefits of gold funds—gold ETFs—in the first place?

Bet Against Monetary Policy

One perspective on gold ETFs is that they are a means to “short” monetary policy. In other words, these kinds of gold-backed equities usually perform well when economic policy—especially the dollar—are lacking clarity and confidence. This was certainly the case during the financial crisis, which saw massive gains for the biggest gold ETF, the SPDR Gold Trust (GLD).

gold-rallyThese types of funds typically track closely along with precious metal prices. (This is not necessarily the case, at least not to the same extent, with gold mining stocks.) Therefore, it made sense that the gold and silver ETFs were especially strong when spot prices were at all-time highs and the economic system seemed in its deepest disarray.

2016 Surge

The same pattern has held true so far in 2016. Not only have these paper assets seen quite a bit of coverage in the news, but they have also provided handsome returns. Across the sector, gold ETF holdings (measured in metric tonnes of gold bullion) have been climbing ever-higher, rising 21% year-on-year on the back of strong global demand. For reasons such as this, proponents of gold ETFs also cite them as reliable proxies for gold demand without all the hassle of delivery and storage.

So far, we’ve seen more of the same. GLD has been a bit choppier of late (just like the gold price). The fund gained 0.9% last Wednesday before giving it all back on Thursday. Trading action was virtually flat on Tuesday.

Reason for Caution

paper gold

Source: Daily Mail (U.K.)

However compelled most gold investors are by exchange-traded funds, investment analyst Cody Willard points out that “we learned in 2008’s financial crisis that paper promises from banks aren’t worth the paper they’re written on when the crap hits the fan. So if you’re using GLD or [the iShares Silver Trust] SLV or other paper promise precious metal ETFs as a hedge against economic/financial crises, then it sort of defeats the purpose of using precious metals as a hedge against black swans or other crises.”

In other words, the gold ETF enthusiasts seem to have their argument only halfway correct: precious metals are a hedge against uncertainty and impending crisis, but holding gold in its “paper” form doesn’t actually accomplish this. Only a tangible asset like physical bullion is truly free from the bounds of the dubious paper markets.

 

The opinions and forecasts herein are provided solely for informational purposes, and should not be used or construed as an offer, solicitation, or recommendation to buy or sell any product.