So you finally decided to invest in gold.
Who could blame you? Gold’s surge to $1,900 per ounce was one of the biggest market stories of 2011, and while prices took a brief retreat, they’re back on the march again this year. Worries about U.S. finances, global spending, energy prices and a host of others have experts predicting everything between a “modest” increase to $2,000 and a rise to $2,500. Heck, one expert even thinks $10,000 gold is on the horizon!
But now that you’ve decided you want in the gold game, you have to ask yourself: How? While getting into gold isn’t as simple as walking up to Fort Knox and charging a bar of bullion to your credit card, investors with a basic brokerage account can play the yellow metal in a number of ways.
Let’s take a look at two of the most common methods of investing in gold — beyond actually buying gold bars or coins, of course:
Physically Backed ETFs
Physically backed exchange-traded funds, or ETFs, are as straightforward as you can get without buying the bars yourself. They’re great for everyday investors, considering the high cost of actually buying, storing and securing gold bullion.
In short, a physically backed fund actually holds the metal, and the fund’s price changes pretty much along with the price of gold (minus the fund manager’s fees).
This makes for a pretty simple investment thesis: If you think gold is going up and you don’t want the hassle of holding gold bars or coins in your basement, buy a fund.
Click to Enlarge The market has a number of physically backed ETFs, but most investors can stick to the two major players: The SPDR Gold Trust (NYSE:GLD) and the iShares Gold Trust (NYSE:IAU), the respective offerings of State Street (NYSE:STT) and BlackRock (NYSE:BLK). These ETFs hold more than $80 billion in assets and are as liquid as they come.
Click to Enlarge As you can see in the accompanying charts, not only do the ETFs ride alongside the price of gold, but with each other. IAU is up just 0.5 percentage points over GLD during the past five years. Hardly a reason to pick one over the other, but if you’re asking, IAU does hold the edge.
That edge is largely because the iShares Gold Trust has a slightly smaller expense ratio — 0.25% to the SPDR Gold Trust’s 0.4%. That means fees eat up less of your returns. But most everyday investors won’t notice the difference, which comes out to $1.50 for every $1,000 invested.
Gold mining ETFs are a more indirect way to play gold.
While trusts like GLD and IAU are more tethered to the price of gold because they hold physical bullion and nothing else, gold-mining ETFs — which hold stocks of companies that mine gold — deviate a bit, for several reasons.
For one, while gold-mining ETFs do benefit from higher gold prices, they also gain and lose value based on their individual holdings’ strengths and weaknesses. And because the ETFs hold equities, and not gold, they’re susceptible to broader market movements.
It’s also worth noting that many gold miners are in regions that can suffer political instability or face poor infrastructure networks, as in many ore-rich African nations.
Another important point is some component stocks in gold-mining ETFs not only mine gold, but other metals like silver and copper. That further separates mining ETFs from the movement of the yellow metal.
The two major players in this field are both Van Eck products: the Market Vectors Gold Miners ETF (NYSE:GDX) and the Market Vectors Junior Gold Miners ETF (NYSE:GDXJ). And while the names are similar (as are their respective 0.53% and 0.54% expense ratios), they don’t share nearly the same connection as GLD and IAU.
GDX tracks an index consisting of large- and medium-cap companies, including the world’s largest gold producer, Barrick Gold (NYSE:ABX), which has a nearly $50 billion market cap. GDXJ deals in small- and microcap companies, with its largest holding — Canadian miner Alamos Gold, which trades on the Toronto Stock Exchange — sporting a market cap of only $2.4 billion.
Click to Enlarge And as you can see in the chart, not only do GDX and GDXJ far differ from the price of gold (represented by GLD), they differ from each other. For instance, GDX has outperformed GDXJ about 17% to 14% since the Junior fund started in late 2009. But if investors cashed out an equal investment of both in late 2010, GDXJ’s return would have been almost 50 percentage points better than GDX!
While the Gold Miners ETF is arguably “safer” than the Junior Gold Miners, both funds offer much more protection than investing in individual mining companies. Each fund holds a basket of stocks at varying weights, limiting the potential damage should one stock fall off a cliff. But that protection also limits your ability to make quick, sizable gains, so more aggressive investors seeking larger returns might be better off targeting individual gold miners.
If you do choose to invest in gold via any of these funds, remember one thing: The precious metal is notoriously volatile, so it’s risky to put too much of your holdings into any gold investment. The returns are there, so many portfolios can benefit from a small position in gold or gold stocks — but always keep in mind that the potential for steep loses is there, too.