The Pros And Cons Of Gold Miner ETFs

August 13, 2012

Look before you leap when it comes to gold miner ETFs.


If the Fed decides to execute more quantitative easing, gold prices are likely to soar. So, what should investors do?

As things stand, many investors use equities to play gold and avoid higher taxes associated with funds structured as grantor trusts. In total, gold miners ETFs have $10.5 billion in assets. But are investors getting the exposure they expect?

The answer is no, and that's largely because the fund names don't reflect what they truly hold.

So, let's start with the six gold ETFs now available:

  • Market Vectors Gold Miners (NYSEArca: GDX)
  • Market Vectors Junior Gold Miners (NYSEArca: GDXJ)
  • Global X PURE Gold Miners (NYSEArca: GGGG)
  • Global X Gold Explorers (NYSEArca: GLDX)
  • PowerShares Global Gold and Precious Metals (NasdaqGM: PSAU)
  • iShares MSCI Global Gold Miners (NYSEArca: RING)


It turns out that gold equity funds often invest in silver and other precious metals. This is partially due to the fact that most of the gold miners ETFs currently available don’t have to replicate their index fully. In fact, only 80 percent has to be invested in the underlying benchmark, whereas most equity funds have a 90 percent requirement.

Therefore, nongold miners infiltrate ETF portfolios, and up to 20 percent of holdings can be unrelated to the gold mining business. For example, Market Vectors’ GDX holds Silver Wheaton, the world’s largest silver-streaming company, as its fifth-largest holding, at 5.21 percent of total assets.

GDX also has a number of smaller silver holdings, such as Pan American Silver, First Majestic Silver, Hecla Mining, Silver Standard and Coeur D’Alene Mines. In addition, firms that are focused primarily on gold mining can also be engaged in the mining of other metals, which can further dilute exposure to gold. Kaminak Gold Corp., for example, deals in nickel and uranium as well.

Although gold and silver are often grouped together, silver is a poor substitute for gold. Gold is primarily used as an investment or in jewelry, whereas silver has numerous industrial applications. According to the World Gold Council and The Silver Institute, over 50 percent of silver is used in industry compared to about 10 percent of gold.

So, the price of silver is more heavily dependent on the demand for the products it’s used in. In other words, silver is more cyclical than gold. The correlation between gold and silver spot prices over the past two years is 0.77, no doubt less than many might think.



Gold Miners Vs. Physically Held

The correlation between the total return of gold equity funds and gold spot prices is lower than expected as well. Over the past two years, correlation between the total returns of GDX, GDXJ and PSAU and the spot price of gold has averaged 0.74, 0.74 and 0.69, respectively.

Unsurprisingly, physically held ETFs such as the SPDR Gold Shares (NYSEArca: GLD), the iShares Gold Trust (NYSEArca: IAU) and the ETFS Physical Swiss Gold ETF (NYSEArca: SGOL) have had a correlation of 0.99 over the same time period.

The return chart below shows returns over the past two years. Once again, equity-based funds are a poor substitute to their physically held counterparts when it comes to matching returns on gold spot prices.


SGOL vs GOLD vs PSAU vs IAU vs GDXs vs GLD vs GDXJ

Source: Bloomberg

The returns for equity funds that are two years or older—GDX, GDXJ and PSAU—are much different than those of the physically backed funds GLD, IAU and SGOL. Although gold has had an overall positive performance over the past two years, gold miner ETFs saw a negative total return.

In fact, the returns of the physically held funds SGOL, IAU and GLD overlap with the gold spot price so closely that it’s hard to distinguish them in the chart.

Gold miner ETFs are also more expensive to hold. On average, they have annual management fees of 0.57 percent, compared with their physically held counterparts, which charge an average of 36 basis points.

Admittedly, physically held funds are not known for their tax efficiency, since they don’t qualify for the 15 percent long-term tax rate that applies to traditional equity investments. Instead, the Internal Revenue Service taxes long-term profits of physically held precious metals funds at a rate of 28 percent, while short-term investments—those held for one year or less—are taxed as ordinary income at a maximum rate of 35 percent.

Investors can mull the pros and cons of equity-based gold ETFs on their own time. But they must understand that buying equity funds provides exposure to mining companies and not to gold spot prices.


At the time the article was written, the author had no positions in the securities mentioned. Contact Ana Kostioukova at [email protected]. Follow Ana on Twitter @AnaKostioukova.


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