Gold ETFs (Exchange Traded Funds)

What is an ETF?

An Exchange Traded Fund (ETF) is a fund which is designed to reflect the movement in price of an underlying asset, or index, or basket of stocks. The shares of the fund are traded on a stock exchange in the same way as shares of publicly traded companies.

Gold ETFs have been created to track the price of gold, or the inverse price of gold (for times when the investor believes the gold price will fall), or an index based on gold mining companies.

Why invest in a Gold ETF?

Whilst many investors buy and sell physical gold, it can be cumbersome and expensive to store. There is also a risk of burglary when storing gold, particularly if stored in the home. Selling gold accumulated can also prove to be worrisome, and time consuming. For those investors who want to trade in gold, either as a hedge, pure speculation, or as part of a diversified portfolio, such problems prove to be stumbling blocks.

Gold ETFs provide a quick and cost effective way to gain exposure to the price of gold for individual investment aims. Shares in gold ETFs can be bought and sold through a broker, and online, in a matter of seconds, so give immediacy to position taking in gold that is far more difficult to achieve by trading physical gold.

ETFs for all markets

Whether you believe the price of gold is going to rise or fall, there are ETFs to suit your view as well as your attitude to risk. ETFs are able to trade in any financial instrument, though what instruments each particular ETF may invest in will be declared in its prospectus and articles.

Some bull gold ETFs (that look to profit when the gold price is rising) are backed by physical gold. This means that they buy enough gold to hold in vaults to satisfy shareholders were the shares to be converted to the physical gold. Others trade in derivative instruments, futures and options, for example, to achieve their aims: this is particularly true of geared bull ETFs and bear ETFs.

Geared ETFs seek to make daily profits of a multiple of the amount that the gold price rises or falls, or a gold market index rise of fall. For example, an investor who is very bullish on the short term gold price might buy an ETF that aims to make 200% of the daily movement of the gold price. This means that any upside on the price of gold will be doubled by holding the ETF. However, it has to be remembered that any downside would also be doubled.

Exposure to a diversified Portfolio in a single trade

Some investors might wish to invest in gold mining stocks rather than physical gold. It might be that the gold mining sector is trading at a large discount to the gold price, and the investor expects this discrepancy to narrow: in other words, he expects the relative performance of gold mining stocks to be better than gold itself.

ETFs based on an index of gold mining stocks give the investor the possibility to take a position on his view with a single trade. The ETF will be invested either in the stocks or derivatives of the gold mining companies that are components of the index, and so the investor effectively opens a position that is immediately diversified across those stocks, and in the weights that will precisely reflect the index make-up.

Trading in a gold index ETF gives immediate exposure, saving time and expense.

Hedging Physical Gold

For an investor who holds, say, gold bullion, but believes the short term price of gold will fall, a bear ETF gives an efficient way to hedge his physical gold position without having to sell it. Once the expected downward move in gold has happened, the investor can sell his bear ETF, which will have risen in price. This will give him a profit to bank against his paper loss on his bullion position.

In Conclusion

Gold ETFs offer investors a fast and efficient way to gain exposure to the gold price and gold mining companies. They can be used to initiate a speculative position, or for hedging purposes, and also to diversify existing portfolios. Of course, an investor should conduct due diligence and research before making any investment decision, and this should include being aware of the tax implications of investments made. Being publicly traded on an exchange, gold ETFs are very transparent, and can be traded in throughout the trading day.

A good place for investors new to the gold ETF market to start their research is the Stock-Encyclopedia.com Gold ETF list.

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