Gold 2011

ETF Entrance Into Gold Rush Proves Rewarding But Volatile

Shelly K. Schwartz, |Special to

There are a lot of reasons to invest in gold, but to ride the extraordinary, multi-year rally underway you don't need to go out and buy some coins or bullion and put it in your bank's safe deposit box.

Gold's low correlation with other asset classes, like stocks and bonds and even other commodities, for example, can help minimize volatility in an otherwise equity-heavy portfolio.

“We are still arguing that people should add gold to their portfolios as part of a diversification strategy,” says Katherine Klingensmith, a strategist for UBS Wealth Management Research. “There’s still quite a bit of concern about the structural integrity of the financial markets, so there are still plenty of folks looking for hedges against continued weakness in the global growth story.”


Truth is, gold coins or bullion are generally unaffordable to all but the most affluent investors, leaving interested average investors mutual funds and exchange traded funds .

And there’s no shortage from which to choose. Some 22 mutual funds and 21 ETFs focus all or most of their investment holdings on gold.

But their investment strategies differ greatly. As such, they haven’t all been buoyed by the modern day gold rush.

Mutual Funds

Most gold mutual funds, for example, are equity-based, investing primarily in companies engaged in the mining, production, processing and distribution of gold.

Thus, they track a stock index like the Dow Jones Platinum & Precious Metals Index, not the price of gold.

Due to increased labor and energy costs, however, such funds have generally fared worse in recent years than their counterparts that invest directly in gold bullion – the commodity itself.

To wit, the FTSE Gold Mines Index, which tracks the performance of all major gold mining companies worldwide, is down more than 6 percent for the first seven months of the year, despite the runup in spot gold prices.

Gold equity-based mutual funds that diversified into physical gold or other precious metals, however, have outperformed relative to their peers.

Vanguard Precious Metals and Mining Fund, for example, a Morningstar analyst pick, is invested in a variety of companies engaged in the exploration, mining, fabrication and processing of precious metals and diamonds. It also invests in energy companies.

The equity fund is up an impressive 33 percent over the last 12 months, and more than 8 percent over the last five.

First Eagle Gold Fund, another Morningstar pick, is also up nearly 29 percent since this time last year and 15 percent over the last five, buoyed by its stabilizing 15 percent stake in physical gold.

Likewise,Gamco Gold Fund is up nearly 23 percent since 2001, a year before the gold bull market began.

Gold ETFs

Most gold ETFs, meanwhile, invest in the commodity itself — physical bullion — with a mission to mirror the performance of spot gold prices, net an “extremely marginal” management fee, says Abraham Bailin, an ETF analyst with Chicago-based fund tracker Morningstar.

SPDR Gold Trust, the most popular gold ETF, for example, is physically backed by gold and moves in lockstep with market prices.

Between October 2008 and July 2011, the London spot fix gold price returned 111.4 percent, with the SPDR Gold Shares fund up virtually the same amount at 110 percent.

Equity ETFs

iShares Comex Gold Trust, its less pricey competitor that trades for $16 per share compared with the SPDR Gold Trust's $160 per share, also invests in physical gold.

“The tracking [of spot gold prices] has been great on both of them,” says Bailin.

There are also a few equity ETFs that invest in gold mining stocks.
Market Vectors Gold Miners ETF for example, which tracks the NYSE Arca Gold Miners Index, is up an eye-popping 188.6 percent since October 2008, largely because the price of gold rendered it economically viable for many of the companies it invests in to ramp up operations on dormant mines, says Bailin.

Boris Engelberg | Stock4B | Getty Images

“They may not have been producing when prices were lower, but as soon as gold reaches that threshold where it becomes profitable to start making cuts into the ground again they not only go from taking a year-over-year loss on that field but they become highly profitable and can even ramp up volume to squeeze as much juice out of that lemon as they can,” says Bailin. “You see that reflected in their shares.”

Such funds, he notes, can be leveraged plays, because at the point of profitability the shares of those companies often climb faster than the price of the metal they mine.

Double Gold ETFs, in fact, seek to double the investment return of either gold bullion or a specific gold index through operational leverage – for better or worse.

If the price of gold goes up by 10 percent, the fund would attempt to return 20 percent.

The reverse, of course, also applies. If the price of gold falls by 10 percent, the fund would tumble 20 percent.
With a one-year return of 87 percent, ProShares Ultra Gold is among them. 

As stock funds, however, all equity ETFs are vulnerable to movements in the overall stock market, management changes and operational challenges.

As such, they are best left to seasoned investors who can stomach a little risk, says Bailin.

Which type of gold fund you select, of course, depends on your objective.

But given its volatility, no investors should have more than 5 percent of their portfolio allocated to gold — or any other commodity, says Bailin.

“If you’re looking to speculate on price movements, you might be able to realize not only spot gains but increased price sensitivity to spot movements with equity offerings,” he says.

But if you’re looking at gold for its portfolio benefits — low correlation with traditional asset classes or inflationary hedge — then gold-backed funds are best, he notes.

“The reason that physical backing is a very preferable way to gain exposure is because when an offering backs its shares with physical bullion, the price performance that you are going to realize is going to be exactly the same as the commodity,” says Bailin. “If you’re looking for portfolio level benefits and very precise tracking, obviously equities aren’t the place to go for that.”