Are you paying too much for your gold?

With investors moving assets to what they regard as safer stores of value that can withstand potential monetary debasement, gold has emerged as a prominent investment category. With the emergence of the exchange traded fund (ETF), investors can now access the same exposures while benefiting from the cost efficiency and liquidity of an exchange traded product.

The tremendous broad-based growth of ETFs in the precious metals space has been followed with great interest by many investors who may be interested in learning more about the differences between ownership through physical bullion and an ETF.

Physical Bullion

The common theme among pricing mechanisms for physical bullion is a relatively high degree of correlation between ease of transport/efficiency of storage and price per ounce. More simply put, if something is easily moved, it is more expensive; to the extent that it is less mobile, the price per quantity will be cheaper.

Investors who opt to invest in their own gold coins and bars will typically evaluate the following options:

  1. American Gold Eagle Bullion – This 22 karat gold coin is legally required to be mined in America. It was first introduced in 1986 and has since become the world’s best-seller, trading at significant premiums compared to the spot gold price.
  2. Krugerrand – First introduced to the United States in 1974, this South African coin was banned from importation in the US for nearly 10 years. Today, Krugerrands sell below Gold Eagle prices and remain popular among gold buyers seeking bargain bullion gold.
  3. Bars – Generally 99.99 per cent pure, gold bars are available in 1oz, 10oz, 1kilo and 100g denominations. Importantly, gold bars sell at smaller premiums (over spot prices) than gold coins. Along similar lines, premiums on larger 1kilo gold bars are US$30-US$50 (S$38-S$64) per ounce lower than premiums on 1oz gold bars.

Exchange Traded Funds

The rise of ETFs with physical underlying brings the best of both worlds; investors enjoy the liquidity of an exchange traded instrument without burdensome transaction premiums that come with gold coin or bar purchases.

Important factors that should be considered when choosing a precious metal ETF include:

  • Know What You’re Buying – Whereas the price of a physical ETF is only impacted by the price of the asset, movements in futures-based ETFs will have other explanatory variables such as roll cost. Further, exchange traded notes and exchange traded commodities may not be structured ideally to protect investors from counter-party risk.
  • Track Record – Physically-backed ETFs, and in particular precious metals ETFs, are truly unique in that the underlying securities are identical in value and are worth very similar amounts irrespective of pricing methods. Therefore, it is all the more important that the issuer has a long operating track record and is experienced in the storage, transportation and proper maintenance of the precious metal.
  • Security – When an investor buys a share of a US listed physical gold ETF, what that individual purchases is shares in a grantor trust, which in turn owns the gold bullion that is stored with a custodian. The issuance of new shares by the trust requires the delivery of gold to the custodian (essentially a “creation”). Specific to gold ETFs there is a risk to investors when the new gold is delivered to the custodian without having prompt transfers of ownership to the trust itself. Fully-allocated ETFs limit the creation of additional ETF shares until the custodian has confirmed the integrity of this process.
  • Transparency – Bullion holdings should be disclosed on a daily basis. Physically backed ETFs should have independent authorised participants, market makers and custodians. Pricing should be simple and readily accessible to investors.
  • Cost – Since gold is not an income-generating asset on a standalone basis, management fees are taken from the underlying holdings; the amount of gold represented by the trust will decrease over its life to pay expenses. As holdings across these precious metals ETFs are effectively the same, investors should be especially cost conscious.

Moreover, precious metals are generally a longer-term investment; the cost savings benefit can be rather substantial over time. If one were to hold a hypothetical ETF charging 0.25 per cent per annum, the cost savings that individual would experience over 10 years compared to the industry average of 0.71 per cent would be just under 5 per cent.

Catherine Barker is director and head of iShares Southeast Asia, BlackRock (Singapore) Limited.

Source: TodayOnline

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