Commodity ETFs: Gold Miners Vs. Gold

An age-old debate in commodity investing is whether to buy the raw material itself or the stocks of the producers of said raw material.

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Exchange-traded funds have made it easier than ever to get exposure to the whole spectrum of commodities, and that includes investments in commodity producers.

Take gold, for example. There are a number of ETFs out there right now that offer exposure to physical gold, which they hold in enormous vaults. Buying a share of such an ETF is as good as going to your local bullion dealer and buying the gold yourself.

Meanwhile, other ETFs allow an investor to purchase a basket of gold miners—firms that are involved in the exploration and development of gold mines, and the production of gold from those mines. While an investment in a physical gold ETF is simple enough—if gold rises in price, you make money; if it falls, you lose money—an investment in a gold mining ETF is much more complicated.

Firstly, when an ETF purchases a basket of gold miners, it is buying a basket of individual stocks. This can either be a good thing or a bad thing. If the entire stock market plunges, gold miners may decline even if the price of gold increases. The opposite could also be true: Miners may rise even as gold falls.

Generally speaking, the correlation between miners and the price of gold is quite high over the long term. But just be mindful that it's not unusual to see the two diverge in shorter time frames.

The next factor that differentiates miners from gold is profitability. In the end, a miner is a company that seeks to maximize profits for shareholders. Profitability is going to vary for each of the miners depending on their output, cost structure and other considerations:

  • Miners can hedge their output (lock in a fixed price), providing steady profits for the firm. But by hedging, the miner won't benefit from any upside in gold prices—or conversely, be hurt by any downside in prices.
  • Management can have a tremendous impact on profitability. Good executives can help a miner remain profitable even in bad times, while bad executives may squander a company's profits even during times of record-high prices.
  • Dividends: One of the biggest knocks on gold is that it doesn't pay any yield to investors. While that's true of the metal itself, gold miners—particularly the larger ones—do pay dividends, and an ETF investor benefits from that.

With everything taken into consideration, it's clear to see that an investment in gold miners is quite distinct from an investment in gold. But it's not just gold and gold miners; these same considerations that we reviewed apply to essentially all commodities and commodity producers.

An investment in an oil company is distinct from an investment in crude oil; an investment in a copper miner is distinct from an investment in copper—the list goes on. It's up to each investor to decide what exposure she wants, and to purchase the appropriate commodity ETF that meets those needs.

Next: How Are Commodity ETFs Taxed?

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