This article is part of Morningstar's Guide to Financial Christmas Gifts. As you consider whether your friends and family have been naughty or nice we'll be revealing all you need to know about financial gifts for Christmas.
Investors planning to stuff their stockings with gold coins this Christmas can consider a range of gilded ETPs (Exchange Traded Products). Although gold has lost some of its lustre over recent years, its core investment properties mean benefits can still be gained from maintaining a small portfolio allocation.
Traditionally gold, as an investment, has been used as a store of value in the face of severe market turmoil. As it holds little ‘intrinsic value’, it can be considered a barometer for investor sentiment, with demand peaking in times of market distress, and falling away in times of relative calm. Besides, in keeping with its role as a store of value, gold may also provide an effective inflation hedge.
Globally low inflation figures amidst an improving economic outlook have seen gold prices drop almost 40% from the highs reached in the summer of 2011. Unsurprisingly, investment vehicles providing exposure to gold have experienced strong net-outflows over the period. For example, in the last two years European-domiciled gold ETPs have seen outflows of almost €10 Billion.
A continued global recovery, led by the US, is unlikely to be supportive of gold prices in the short-to-medium term. And yet there are still sound reasons for assigning the precious metal a small portfolio allocation. Most notably, gold’s historically low- to negative- correlation with most broad asset classes can bring welcome long-term diversification benefits.
Modern portfolio theory shows that adding a commodity such as gold to a stock and bond portfolio has historically produced lower volatility and increased risk-adjusted returns. While falling gold prices in booming markets may reduce returns, the potential gains in more turbulent market conditions can offset falling prices in other assets classes.
ETPs represent the cheapest, most easily accessible and liquid vehicles providing exposure to gold as an asset class. The vast majority of European-domiciled ETPs take the form of ETF (Exchange Traded Fund) or ETC (Exchange Traded Commodity). Generally speaking, ETFs may be UCITs compliant, while ETCs are not. For further information on the differences between these structures please read a previous series of articles covering the topic.
When investing in gold via ETPs, the most straight-forward way is via physical gold vehicles. These funds take investors’ money and invest directly in the underlying commodity. This structure has a pleasing simplicity and it can be reassuring for investors to know that their investment is backed directly by the underlying commodity.
As gold does not generate cash income to offset any holding costs or commissions incurred, management fees are either levied directly or subtracted from the amount of physical gold held on behalf of the investor, in which case it will gradually be eroded over time. Investors should be aware that most physically-backed vehicles place restrictions on investors’ access to the underlying gold. Investors seeking direct physical exposure can consider the iShares Physical Gold ETC (SGLN), which charges a TER of 0.25% which is lower than its peer-group.
As it is valued in USD, for a non-US investor buying gold is a joint bet on the price of gold and on the strength on the Dollar. For example, A UK investor may still lose money even if gold prices are rising, if there is a simultaneous drop in the USD/GBP exchange rate. Over the years, the gold ETP offering in Europe has evolved to account for these foreign exchange implications. Investors can now choose from an array of gold ETPs which use forward contracts to hedge away the currency risk. This in-built feature normally comes at a cost relative to plain USD-denominated vehicles. For example, the db Physical Gold GBP Hedged ETC (XGLS), charges a FX hedge fee of 0.4% in addition to a TER of 0.29%. Currency hedged variants are available for other major currencies such as the Euro.
Another ETP option available to investors is gaining ‘pure play’ exposure to gold through the investment in gold producers. Under this structure the vehicle invests in the equity of firms that are involved in the exploration and production of gold and related products.
This approach may be attractive to investors who are seeking income from dividends or those that are unable or unwilling to invest in non-UCITs products, but still wish to participate in gold price movements. The main drawback of this approach is that investors assume additional ‘market risk’ when investing equity, which dilutes the potential diversification benefits associated with the asset class. Investors seeking equity-based exposure can consider the iShares Gold Producers iShares Gold Producers UCITS ETF (IAUP) which charges a TER of 0.55%.
