Barclays Global Investors Files for Gold ETF

February 09, 2004

Golden Launch in London

The London launch of the Gold Bullion Securities has made an even bigger debut than the Australian launch.  Like the Australian project, the London Gold Bullion Securities (London Stock Exchange symbol GBS) is also owned and run by a partnership of the World Gold Council (which aims to market Gold and is owned by a conglomeration of large gold companies) and Gold Bullion Limited, which actually runs the ETF, and is owned and managed by Graham Tuckwell, whom we interviewed and quoted earlier in this article.  In its first day of trading on London Stock Exchange on December 9th, GBS attracted sales of more than $330m (£196m).

Since the U.K. fund has been trading for less than a month, gold shares still entitle investors to 99.98% of 1/10th of an ounce of gold.  Over time, because of fees and cost of carry, the fund will gradually have slippage that will cause its price to misalign with the actual price of the underlying gold. However, the tracking is fairly close, and we have heard discussion about the possibility of doing some sort of a periodic rebalance to bring the share prices back in line with the 1/10th of an ounce spot price of gold.

The $330 million in sales on the first day of trading means that the U.K. Gold Backed Securities put 8.2m shares to market, each one backed by one-tenth of an ounce of gold, equating to 820,000 ounces or 25.6 tons.  According to Gold Fields Mineral Services, the total net global investment in gold last year was equivalent to 128 tons.

What the World Gold Council is waiting to see is the degree to which there is institutional and retail demand for a gold asset class as a hedge against inflation and a declining equities market.  Some industry analysts think that gold ETFs have the potential to become extremely successful, and if this occurs, it can only work to push the price of gold higher.

For the Gold ETF, the fee structure is extremely favorable to investors who might otherwise pay upwards of 7% sales costs to buy physical gold.  The fund has a management fee of 0.30%, a creation fee of 0.10%, and a storage and insurance fee of 0.10% for a total fee of 0.5%, which is deducted from the fund's holdings on an ongoing basis. Roughly, this is expected to translate into the following share values vis a vis the spot price of 1/10th of an ounce of gold. The attraction of GBS to investors is its low transaction costs of less than 0.5% per trade compared to costs of up to 7% for buying physical gold.

 

Share Value as % of Price of 1/10 Ounce Gold

At Fund Inception

100.0%

At January 1, 2005

99.7%

At January 1, 2006

99.4%

At January 1, 2007

99.0%

Unlike with the Australian Gold Bullion Securities, which have a minimum creation amount of AU$500,000 with the London ETFs, there is no minimum creation size for ETF shares of the London Gold Bullion Securities, and no restriction in who may apply for a creation.  Just apply and send your gold bars to the Gold Trust Account, and you will be issued shares.  For redemption, only Approved Holders may redeem in actual physical gold, although the fund has the added feature that any shareholder can redeem shares for U.S. dollars, British Sterling or euros - less applicable fees.

The U.S. product is filed to run very differently than either the London or Austalian ETFs, with a creation basket of a minimum of 100,000 shares, with each share priced at about the value of 1/10th of 1 ounce of gold, or about $42.50 as of publication.  Two potential downsides of the ETF structure are:

  1. The Fund will gradually lose gold as it is sold to cover the ongoing expense of the fund (which in the case of the U.S. fund are expected to be at 0.30%, falling gradually, to, for example 0.16% if/when the fund reaches the $20 billion level of assets.  Still, as you can see from the table above for the U.K version of the fund, each share will own a little less gold over time (1% less after 4 years in the U.K., where the fund has a higher expense ratio beginning at roughly 0.50%.
  2. Strange though it may sound, gold, even gold bars in a vault, are treated as a special category of assets, 'collectables,' (artwork would also fall under this category) and are therefore taxed at a higher 28% capital gains rate in the U.S. even after being held for more than a year.  Like any asset, if you sell it within a year, it is taxed as ordinary income.

Another Option: CME Launches Gold TRAKRS Futures

In early December, the Chicago Mercantile Exchange (CME) launched an innovative new future, the Gold TRAKRS (Total Return Asset Contracts) futures, which is the sixth in a series of non-traditional futures products developed jointly by CME and Merrill Lynch.  It immediately became the most successful of these launches, trading 5,759,346 Gold TRAKRS contracts representing approximately $144 million on its first day of trading.  

Futures on gold have long been available from the major commodities markets.  Trading is brisk on Gold futures that trade on the Chicago Board of Trade (CBOT) and in the COMEX division of the New York Mercantile Exchange (NYMEX).  The new offering by the CME adds another twist, though. The Gold TRAKRS Index is designed to track the spot price of gold and a total return component that will reflect an accrual at a rate equal to the one-month lease rate for gold.  

Therefore, these futures are set up to not only track price movement, but also to provide you with the income that comes from lending gold, as if you were holding the bullion and had the market power of Central Banks or major bullion dealers. The lease rate is intended to represent the compensation an owner of gold would receive in return for lending gold for a period of one month. 

The TRAKRS, like ETFs, are also and index-focused product. They are designed to enable investors to track an index of stocks, bonds, currencies, commodities or other financial instruments.  Previous TRAKRS offerings include Long-Short Technology TRAKRS, Select 50 TRAKRS, LMC TRAKRS, Commodity TRAKRS and Euro Currency TRAKRS.  TRAKRS are the first broad-based index products traded on a U.S. futures exchange that can be sold by securities brokers. When purchased by non-institutional investors, they are the first futures contracts that can be held in securities accounts.  

Some of the differences between TRAKRS and traditional futures include:

  • Are not leveraged for most long non-institutional investors, who are required to post 100 percent of the TRAKRS market value at the time of purchase. 
  • Non-institutional investors establishing short TRAKRS positions post 50 percent of the price.   
  • Securities brokers, subject to notice registering with the National Futures Association, are able to solicit trades in TRAKRS from non-institutional investors.

TRAKRS contracts may be held until their expiration (generally three years from their offering date), when they will be cash-settled, or they may be liquidated on GLOBEX (CME-s trading platform) during trading hours.

The world of gold is clearly changing.  New trading instruments will make gold more accessible to both retail and institutional investors than it has ever been before. A combination of factors - what happens in the equity markets and with gold prices, how aggressively the funds are marketed, and to what extent investors harbor a deep-seated desire to own some gold - will all be keys to the level of success the products will achieve.  I wouldn't be surprised, however, if it is quite significant.

For much more information regarding gold, including links to some of the sources that provided the basis for much of this article, please visit our Gold/Commodities microsite.

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