While the gold price has recovered from the low of US$1,321.35 an ounce it reached in April back up to around US$1,400, its price is still well off the record US$1,924 it achieved in September 2011.
So what does this mean for gold ETFs? Experts say gold still has a place in a portfolio as a defensive asset. The relatively depressed price could also be seen as a buying opportunity.
Danny Laidler, head of ETF Securities in Australia and New Zealand, says the recent drop in the gold price can be attributed to short-term technical investors who will sell gold when it reaches a certain price.
“Long-term investors, especially those who are investing their own money, are still holding gold as a defensive asset,” he says.
As evidence, Laidler says net outflows from its gold exchange traded products (ETPs) since the start of the year is $40 million from total assets under management of $550 million. Net outflow refers to the average of money invested and withdrawn from these products.
“This supports our understanding that short-term technical investors have sold out but long-term investors are still holding gold,” he says.
According to Laidler, despite the drop in the gold price the reason why people want to invest in gold ETPs has not changed. “Devalued currencies, US and Japanese quantitative easing and the European Central Bank’s recent rate cut mean investors still want to hold gold,” he explains.
Another reason why people still think gold is attractive is because its performance is uncorrelated to other asset classes such as equities.
“Gold protects portfolios from market shocks,” he says.
The benefit of investing exchange-traded gold products instead of companies such as Newcrest Mining, a gold exporer, is that investors are not exposed to company, mining or equity risk.
Gold ETPs and ETFs are also relatively cheap to buy and they are traded on securities exchanges, which means they are liquid. ETF Securities’ gold ETPs are also backed by real bullion and investors can redeem them for bullion.
But gold as an investment does have its drawbacks. For instance, Mark Oliver, head of retail with investment house BlackRock, points out that unlike other asset classes, gold ETFs and ETPs don’t provide investors with income. BlackRock sells ETFs under the iShares brand, but does not have a gold product.
“Investors are comfortable seeking income outside gold, and our inflows reflect that, but gold does have a role as a diversifier or core stabilising asset,” says Oliver.
Peter August, CEO of Melbourne Mint, also has strong opinions about gold exchange traded products. He believes buying physical gold is a safer and better option.
“There is a massive discrepancy that exists between paper gold, ETFs and physical gold. There is a misconception they are interrelated, but in fact we are dealing with very separate financial products with competing drivers,” says August.
“Paper gold and ETFs have many counterparty risks. It’s important investors understand this. That said, investors are becoming more and more savvy, which is evident in the increase in the number of investors looking into investing in physical precious metals. But there’s still a big education conversation that needs to be had,” he adds.
As to the future direction of the price of gold, Alex Vynokur, managing director, BetaShares, says on a short-term view, it’s hard to see catalysts for a major increase in gold prices.
The only gold ETF that’s traded on the Australian Securities Exchange is the BetaShares Gold Bullion ETF, which is also backed by physical gold bullion.
The main difference between ETF Securities’ gold ETP and the BetaShares’ product is currency hedging. The ETF Securities’ product is unhedged, while BetaShares’ gold ETF is hedged for the Australian dollar.
What this means is that people who invest in the BetaShares ETF are getting pure exposure to the price of gold, without exposure to movements in the Australian dollar/US dollar exchange rate. The ETF Securities’ product is not currency hedged, so investors in this product want exposure to movements in these currencies, as well as exposure to the price of gold.
Vynokur points out that most trading in gold (and other commodities) is done through futures, which inherently hold a leveraged position. As a result, the price of commodities such as gold often overreacts on the upside and downside.
“We think the long-term thesis for gold is sound. The expansion of central bank balance sheets through quantitative easing and other policies in the US, Japan, Switzerland and the UK will trigger higher inflation and boost gold prices,” he says.
From the perspective of professional traders, Vynokur says there is three critical prices traders are watching.
“Technically, current levels of support sit at approximately US$1,310 [per ounce]. If that price is breached there is further support at US$1,245 and then US$1,150,” he says.
According to Vynokur the production cost of an ounce gold is approximately US$1,150, which represents a potential floor in prices as further production at this level would be unprofitable and would constraining supply.
Vynokur says there are many benefits of holding gold exchange-traded products over other investment products that give investors an exposure to gold.
“Traditionally, the only way to gain direct exposure to the gold price was through direct gold ownership or the use of gold futures. Direct gold ownership involves a number of complications and costs, including high minimum investment levels and the costs of buying, physically storing and insuring the gold,” he says.
“In addition, liquidity levels may be low relative to exchange-traded alternatives.”
Gold futures can also be complicated to purchase, requiring an understanding of derivatives, tolerance for margin calls, experience in futures trading as well as potentially high minimum investments.
Vynokur stresses gold ETFs are the easiest way to get exposure to the gold price, however he does acknowledge they are not the only way for investors to get access to the glittery stuff.
“Should an investor have a negative view on the price of gold, or not want gold exposure, it would not make sense for them to use a gold ETF.”
First published in the Australian Financial Review 29 May 2013 http://www.afr.com/p/gold_still_has_place_in_the_portfolio_HmQnrfW81xzmkzR28rHGMK