Gold ETF Returns Show Huge Disparity

April 19, 2013

In the recent gold plunge, not all ETFs are equal.


Amidst the recent plunge in gold prices, ETFs have shown a huge disparity in performance—some gold ETFs have declined as much as 20 percent, while others have escaped nearly unscathed.

The differences in performance can be attributed to the method through which each fund gains exposure to gold. That exposure can be broadly grouped into three categories: gold miner equities; futures-based strategies; and physical funds.

Gold miners are one way to gain exposure to gold-linked equities; these ETFs invest in the common stock of gold mining companies. In theory, this is a legitimate way to gain exposure to gold; after all, if the miners control new supply on the market, then they ought to be able to leverage increases in gold prices which, in turn, ought to boost their bottom line.

The problem with gold miners, however, was best presented by hedge fund titan John Burbank as an analogy: Investing in gold miners is like using a winning lottery ticket to buy more lottery tickets.

The analogy isn’t perfect but the point is clear: In the long run, the share price of equity miners will not keep pace with increases in the price of gold.

Investors can also choose to get gold exposure through futures-based gold ETFs, which are portfolios that buy futures contracts on gold. By purchasing a futures-based gold ETF, you own a portion of the right to buy gold in the future at a predetermined price.

These ETFs systematically roll from one futures contract into another as the contract approaches maturity. Contract selection methods vary from fund to fund, but the essence is the same.

The argument for futures-based strategies is primarily one of cost: Physically backed ETFs—which I’ll turn to momentarily—incur the costs of storing, protecting and counting gold. As you can imagine, those costs aren’t menial, but whether or not futures strategies are actually more cost-effective than physically backed portfolios is debatable.

The last category of gold ETFs includes funds that buy and store physical gold. This option appeals to many investors because of its simplicity and security.

One of the most popular reasons people choose to invest in gold is as a hedge against some form of a global economic collapse. In that sense, many seem to feel reassured that if the world comes crumbling down, they at least have gold stored in vaults in London, New York or Singapore.

Now, these different approaches certainly fared very differently in the recent gold downturn, as the table below shows.

Gold Return Breakdown



Gold miner ETFs have clearly been hit the hardest in gold’s recent drawback, while physically backed and futures-based strategies fared much better, although still poorly.

In a discussion about gold miner ETFs, my colleague Dennis Hudacheck quippingly remarked that those holding gold miners ETFs are in a paradoxical situation, where those products have lost a quarter of their value at a time when equity markets are at all-time highs. What happens if equity markets tank?

Still, the argument can be made that these securities would perform strongly in a falling equity market, although historically, the results have been mixed.

In gold’s recent downturn, equity markets also performed poorly, so it seems gold miner ETFs have gotten the worst of both worlds, simultaneously exhibiting characteristics of commodities and equities. In other words, with both markets headed downward, the effects were compounding for gold miner ETFs.

So if gold rebounds and equity markets head upward, will gold miners outperform? Maybe, but not necessarily. Again, gold miner equity ETFs display characteristics of both equities and commodities, adopting strong correlations to either market over various time horizons.

On the other hand, the physically backed strategies such as the iShares Gold Trust (NYSEArca: IAU) and futures-based strategies such as PowerShares’ DB Gold Fund (NYSEArca: DGL) tend to perform similarly over most time horizons and, in general, both track the price of gold fairly consistently.

Going With A Specialty Approach

There’s also two specialty gold ETFs that are worth discussing here: Credit Suisse’s Gold Shares Covered-Call ETN (Nasdaq: GLDI) and RBS’ Gold Trendpilot ETN (NYSEArca: TBAR).

GLDI writes covered calls on a physically backed gold ETF, the SPDR Gold Trust (NYSEArca: GLD). The idea is to provide regular income from the premiums received on call options. The consequence of this strategy is that you’ll miss out on any gold rally more than a couple percentage points because you sold your upside in the form of a call option.

Thus, with GLDI, upside is limited and your only downside protection is the premium received on the call options, which doesn’t provide much cushion when markets turn down sharply. Sure enough, GLDI performed very similarly to physical gold products: It declined 11.92 percent from April 11 to April 16.

TBAR, on the other hand, tracks the spot price of gold when it is at or above its 200-day moving average for five consecutive business days, and 3-month Treasurys when it’s not. In other words, the ETN tries to track gold when it looks strong by technical measures and switches its exposure to government T-bills when gold is technically weak.

In the recent downturn, this strategy performed as advertised on the tin—gold was below the ETN’s threshold; thus, TBAR was tracking T-bills and was resilient in the downturn: The fund actually gained 0.02 percent from April 11 to April 16.

Unfortunately, this has been TBAR’s only true test since its launch two years ago, so we can’t be certain yet that its methodology will provide the same level of protection ahead.

Ultimately, investors ought to select the gold ETP that matches their risk and return objectives the best.

At the time this article was written, the author held a long position in ETFS' Physical Asian Gold Shares (NYSEArca: AGOL). Contact Spencer Bogart at [email protected].

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