As many investors have learned recently, financial innovation comes with a price. The cost of credit default swaps, for example, is opacity. Very few investors knew how the bloody things worked or how they'd behave under market stress, until they blew up.
Not all new financial products are time bombs, though. Some are simple enough to understand, but still require scrutiny by investors to appreciate all of their nuances.
Take the recently introduced UBS E-TRACS S&P 500 Gold Hedged Index ETN (NYSE Arca: SPGH). These notes—unsecured, zero-coupon obligations of the Union Bank of Switzerland's Jersey branch (that's the Isle of Jersey, not the Garden State)—are designed to deliver the combined returns of the S&P 500 Composite and long positions in nearby COMEX gold futures. The notes accomplish this by tracking an index that equally weights—by way of monthly rebalancings—the equity and gold exposures.
Zigging And Zagging
The correlation between gold and blue chip stocks is historically low or, as now, negative. Presently, the rolling 30-day correlation between COMEX gold and the S&P 500 is -24 percent.
Thus, for now, gold provides the "zig" to an investor's portfolio, while the stock index delivers the "zag."
That's not always so, however. As you can see from the graphic below, gold and stocks are sometimes fellow travelers. In the early part of this year, for example, the correlation peaked and lingered at 80 percent—positive 80 percent.
S&P 500/COMEX Gold Correlation
So there's your first caveat: Gold's diversification benefit is an ethereal thing. Sometimes it's powerful; at other times it's nonexistent and may, in fact, be a detriment, riskwise.
SPHG has just logged its 90th day of trading, so now's a good time to take a look at the notes' behavior to see if they're actually delivering a benefit that justifies their cost. At 85 basis points (0.85 percent), SPHG's investor fee—as exchange-traded notes go nowadays—is not the most expensive item on the market.
You have to wonder, though, if you couldn't do the same thing on your own by combining exchange-traded securities tracking the S&P 500 and gold. After all, you can get the blue chip exposure for only 9 basis points through the Standard & Poor's Depository Receipts (NYSE Arca: SPY) or the iShares S&P 500 Index ETF (NYSE Arca: IVV). And gold bullion exposure can be had—without fear of contango—for just 40 basis points with an investment in the SPDR Gold Shares Trust (NYSE Arca: GLD). An equally weighted combination of the equity ETF and the gold grantor trust would effectively cost just 25 basis points. But would you get the same results with the "do-it-yourself" version?
