Why New Gold Fund OUNZ Isn’t A Gimmick

May 19, 2014

The latest physical gold ETF might very well shake up the space anchored by 'GLD.'

The long-awaited Merk Gold Trust ETF (OUNZ) finally launched last week. The trust, which owns physical gold bars much like the SPDR Gold Trust (GLD | A-100), includes a groundbreaking feature—it allows even small investors to redeem their shares for gold.

No doubt, physical gold ETFs, like GLD and the iShares Gold Trust (IAU | A-100), have already been on the market for nearly a decade now, and like OUNZ, they also hold physical gold bars in some of the world's most secure bank vaults.

But those bars can only be claimed by an authorized participant, and only by redeeming whole creation units—in GLD's case, a block of 100,000 shares worth about $12.5 million at current prices. Here's where OUNZ stands out: It allows any investor to make a redemption, even in amounts as small as 1 troy ounce.

That redemption isn't free. Merk charges a fee to pull gold out of the fund in exchange for shares, and this fee varies depending on what kind of bar or coin you want. The transaction would be subject to either a minimum fee or a fee per ounce (whichever is bigger), as laid out by the fee schedule below:

Fee Per
Ounce
Minimum
Fee
1oz. American Gold Eagle $60 $2,500
1 oz. American Buffalo $60 $2,500
1 oz. Australian Kangaroo $40 $1,600
1 oz. Canadian Maple $42 $1,600
1 oz. Australian Bar $30 $1,200
10 oz. Australian Bar $25 $1,000
London Good Delivery Bar $32 $0

For example, if you were to redeem a single ounce of American Eagles, you'd pay $2,500 to do so. Some quick arithmetic shows you'd have to take delivery of about 40 ounces of gold at once, currently worth slightly more than $50,000, to avoid the minimum fee. That's not out of reach for an individual investor, but it's hardly chump change. Taking delivery of a single 1 ounce coin—or even several—is not advisable.

So, is OUNZ's redemption feature just a novelty?

 

I don't think so. While it might not be as convenient as it would appear at first blush, the redemption feature still conveys several benefits.

First, it gives investors an option, and that has value. Gold investors who think they might want to hold physical gold coins or bars someday can buy OUNZ for now, knowing they can easily redeem their shares for gold in the future.

The fund's small handle (just 1/100th of an ounce of gold) means that small investors can accumulate shares of OUNZ in small chunks over many years, and then redeem once they have enough to make self-storage economical.

It's also possible to do this by accumulating shares of GLD or IAU, then selling and using the cash proceeds to buy gold, but there's a problem with that: taxes. If the value of gold appreciates while you're accumulating shares, you'll owe taxes on the gain upon sale, charged at the 28 percent collectibles rate. With OUNZ, that's not a problem. Since the gold you receive by redemption already belongs to you, it's not a taxable transaction.

But aren't those fees exorbitant? After all, redeeming for 50 ounces of Gold Eagles would result in a $3,000 fee on a $65,000 transaction. That's 4.6 percent!

Actually, the fee simply reflects the convenience premium that gold coins command in the market. Here are the exchange fees compared with the premiums over spot charged by two major online gold retailers:

OUNZ Kitco Apmex
1 oz. American Gold Eagle 4.63% 3.92% 3.78%
1 oz. American Buffalo 4.63% 4.24% 3.93%
1 oz. Australian Kangaroo 3.08% N/A 2.78%
1 oz. Canadian Maple 3.24% 2.73% 2.39%
1 oz. Australian Bar 2.31% N/A 1.77%
1 oz. Australian Bar 1.93% 1.92% 1.62%

 

 

 

 

 

Assuming 50 oz. are exchanged at a spot price of $1296.80/oz. Shipping and insurance to the continental U.S. are included.

 

While OUNZ redemptions aren't the cheapest option, they aren't unfair—especially after accounting for the commissions and trading spreads you'd have to pay to sell shares on the market.

Finally, the redemption feature addresses some of the "paper gold" criticisms that have dogged GLD and IAU. While OUNZ won't put to bed conspiracy theories about how much gold these funds actually own, the redemption feature functions as a guarantee of good faith on Merk's part. If the trustee has to make in-kind redemptions to any investor on demand, they had better have the gold to back it up.

In any case, investors in OUNZ should sleep better knowing that they could, theoretically, withdraw their gold from the fund at any time, even if they have no current intention of doing so.

With a fee of 0.40 percent—equal to GLD and only 0.15 percent more than IAU—OUNZ is well positioned to shake up the gold ETF market. If it catches on, we might even see individual redemptions show up in other ETF segments as well.


As the time this article was written, the author held no positions in the securities mentioned. Contact Scott Burley at [email protected].


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