Barclays Global Investors Files for Gold ETF

February 09, 2004

Follows on the heals of Equity Gold Trust's filing to launch a new gold-bullion based ETF in the U.S.

San Francisco - February 9, 2004.   Barclays Global Investors is now the second entity to file an exchange-traded fund based on gold bullion.

On Friday BGI filed with the SEC to launch a new exchange traded fund for gold investors, to be called iShares COMEX Gold Trust. COMEX is the exchange market on gold futures contracts operated by Commodity Exchange, Inc., a subsidiary of New York Mercantile Exchange, Inc.

The iShares gold ETF be listed on the American Stock Exchange with the ticker symbol IAU, pending regulatory approval. The objective of the trust is for the value of the iShares to reflect the price of gold owned by the trust at that time, less the trust's expenses and liabilities.

The BGI filing follows a previous SEC filing by Equity Gold Trust to launch a new U.S. gold-bullion based ETF that, if approved, will trade on the NYSE. According to the filing, a share would represent one tenth of an ounce of physical gold.

In 2003 the first gold ETF, Gold Bullion Securities, began trading on the Australian Stock Exchange, it also now trades on the London Stock Exchange.

Investors have long turned to gold in times of market uncertainty, and many conservative investors have held a part of their portfolios in bullion or gold mining stocks. Furthermore, gold is considered the ultimate inflation hedge, and with economic growth surging in much of the world, gold bugs see a fundamental reason for the metal's rise as well.  Like the fixed-income and value equity investors of the late 1990s, the precious metals crowd took a beating through the last bull market. Now they're back with a vengeance.


         Data as of December 31, 2003.  More data and charts available at www.gold.org.

One problem with gold investing has been that it is historically one of the most inconvenient asset classes for an average investor to access, due to the high costs associated with purchasing, transporting, and safely storing it.  Yes, there are many gold mining companies and mutual funds that invest in mining companies - even Vanguard has such a fund.  And these stocks do, to some extent, capture the price movement of gold.  But many companies are hedged against price movement and involved in other mining activities - and well, they're just not gold.  However, the problem with buying bullion is about to change in the U.S.

Already, investors in the U.S. can buy gold futures to achieve gold exposure, as well as Total Return Asset Contracts (TRAKRS) futures contracts that give similar exposure to the price movement, but also provide a return component to investors - giving them the benefits of lending gold, as if they were holding the bullion (and had the market power of Central Banks or major bullion dealers).  In addition, new exchange-traded funds (ETFs) in Australia and now in the United Kingdom have enjoyed wildly successful launches.  These ETFs actually allow investors to hold gold bullion itself, as stacks of real gold bars in London are what underlie the ETF portfolios.  Like any ETF, shares can be bought and sold through any broker like a single stock.  And they are coming to the USA soon.

Here is the Registration Statement for the Equity Gold Trust's filing to launch a new gold-bullion based ETF that is slated to trade under the ticker symbol GLD on the New York Stock Exchange, with the World Gold Council as sponsor and the Bank of New York as Trustee.  Anticipation for the product in the U.S., and trading in the U.K. and Australian products already trading has been so strong, that some veteran gold traders have said that it is pushing up the price of gold globally.

Why cover all this ruckus in an index publication?

1) Well, whatever may happen to them in the future, the ETF structure is first and foremost an index structure.  It's ours.
2) Index investors have long been a conservative lot, and I know more than a few, including myself, who have dabbled in gold as a hedging asset class.
3) Most importantly, there have been indexes covering the gold market for a long time.

The big three gold indexes all enjoyed spectacular gains in 2003, but the Amex Gold Bugs Index (HUI: news, chart, profile) closed up more than 67 percent for the year:

  • The Amex Gold Bugs Index (HUI) was up 67% in 2003
  • The CBOE Gold Index ($GOX) was up 44% in 2003
  • The Phili Gold & Silver Index ($XAU) was up 42% in 2003

Gold stocks have not done too poorly on a 5-year basis either, as can be seen from the chart below, which compares 5-year returns of the S&P 500 and Amex Gold Bugs Index.

Source: CBS Marketwatch and BigCharts. 5 year returns of the  S&P 500 (red)
and Amex Gold Bugs index (blue) as of Jan. 2, 2004.

Coming Soon to a New York-based Exchange Near You

While it has been eagerly anticipated since it filed with the SEC in May, the World Gold Council sponsored ETF, which has already come to the market in Australia and the U.K., has been delayed at the SEC.  It is our understanding that the gold bullion-based ETF may now be very near to launch in the U.S., as the SEC has been actively working on the application, and seems to be comfortable that its investor-protection concerns have been met.  The ETF would trade on the NYSE under the ticker symbol GLD.

Although no one who is working on the ETF can directly speak to the press during this "quiet time," it is our understanding that those working on the project are extremely optimistic about the prospects for the bullion-based ETF. They view it as a potential breakthrough product along the lines of the Nasdaq-100 'cubes' (QQQ) in the late 1990s that could reach $10 billion or more in assets within a year of launch.  There is the sense in the ETF community that gold, and perhaps actively-managed ETFs after it, represent the next steps up in ETF development. 

Barclays Global Investors may think so, as we/ve heard they may be working on a gold bullion-based ETF themselves. They had earlier tried to bring a gold companies-based ETF to market in the U.S.  (like the one they have in Canada) but ran into Registered Investment Company (RIC) compliance issues, because of the necessary lack of RIC-compliant diversification with any possible Gold mining companies index. We have also heard rumors that there may be one or more other innovative gold-based ETF proposals under discussion as well.  Certainly the idea is creating a lot of interest.

Back to Basics

Index innovation has come to the rescue in the form of futures tracking gold indexes, and now a previously index-only tool - the ETF - is gaining the ability to trade an underlying portfolio of gold bullion on the stock market like any ordinary equity. The ETF structure has come full circle, as it had its origin in the mind of a resourceful commodities trader, Nate Most.  While working at the AMEX, Most had the idea of packaging a mutual fund into a single certificate (like the pieces of paper that represent underlying commodities and trade on commodities markets) that could then be traded in smaller pieces as individual stocks representing a small portion of the larger portfolio.  (See Most's upcoming article in the Q1, 2004 issue of the Journal of Indexes).

What we can say with some degree of confidence is what the structure of the Gold Council's ETF, should it make it though the SEC largely intact, will look like, because the funds that have already been launched in Australia and in the United Kingdom will serve as models.

In short, the London-based World Gold Council, a trade group interested in marketing gold to individuals, will serve as the sponsor for an ETF that will be composed of gold bullion. Equity Gold Trust, which will trade on the New York Stock Exchange under the  ticker GLD, will be backed by gold bullion deposited in a vault in London. The initial share offering will be at a per share price based on one-tenth of an ounce of gold at the time of the offering.

Australians First To Market With Gold ETF

Australia won the race to list the world's first gold-backed ETF (and the first ETF based on any commodity for that matter) by listing an ETF backed by gold bullion. And why not?  The international symbol for Australia is, after all, AU.  The new listing of Gold Bullion Securities (ASX Code: GOLD) on the Australian Stock Exchange enables investors to buy shares that are priced at the equivalent of one-tenth of an ounce of gold.

The new ETF provides investors with the opportunity to buy a physical interest in a bar of gold. Like equity-based ETFs, pricing of shares is kept in check by the ability of investors to redeem shares for the underlying portfolio. This arbitrage opportunity keeps the price of the ETF very close to the actual price of one-tenth of an ounce of gold. The physical gold is insured and held in London vaults by the custodian bank, HSBC Bank USA.  The new ETF has grown exponentially in assets in its first 10 months of existence, and its twin fund in the U.K. (more detail below) has made and even bigger splash. 

 

The development of the new ETF is a joint initiative between the World Gold Council and an Australian company, Gold Bullion Limited. The World Gold Council is the cooperative international marketing organization of the gold industry, while Gold Bullion Limited is responsible for the management of the fund in Australia.

"In the past, many investors have found investing in gold a cumbersome and costly process. Retail and institutional investors have encountered barriers to entry in the form of difficulties with purchase, storage and insurance. The securitization of gold, as proposed by Gold Bullion Limited in this Australian initiative, is a means of addressing these issues," said Jim Burton, chief executive officer of the World Gold Council and former CEO of the California Public Employees Retirement System (Calpers), a position he held from 1994 through until he began working for the Gold Council in September of 2002.

The new gold bullion ETFs are created and redeemed in baskets valued at AU$500,000. The creation basket is a combination of gold bullion and a small amount of cash. (By way of comparison, in the U.S.for example, with equity index ETFs, creation units consist of 50,000 ETF shares and a small cash amount.) Graham Tuckwell, chairman of Gold Bullion Limited, said that shares clear in T+3, which works well logistically for creations, as gold on the Londonmarket clears in T+2.

"The gold market in Londonhas tremendous liquidity, and this underlying liquidity is reflected in the close tracking of the shares to the price of gold." said Tuckwell.

The fee structure for the Australian ETF varies slightly from that of its U.K. cousin.  The Australian fund has fixed management fees of AU$350,000, and a storage and insurance fee of 0.10%. It also has a creation and redemption fee of 0.10% and a nominal redemption fee of AU$100.  A gold sales charge of 0.02% per month or 0.24% per year is charged to the fund, although this fee could change with notice.  Thus, at current asset levels the fund's total ongoing expenses amount to about 0.69%, although this could decline significantly as the fund grows.  At AU$500 million in assets for example, the total ongoing fees (exclusive of the 0.10% creation fee) would be 0.41%.  The Londonfund charges a flat fee of 0.30%, plus 0.10% storage and 0.10% creation fee (see more detail below).

Creations and redemptions can only be made in units of gold bullion amounting to AU$500,000 by an Approved Dealer.  The structure is very similar to that of any other ETF, with the underlying portfolio being held by a trustee.  The only difference is that in the case of the Gold Bullion Securities (Gold) the underlying portfolio is not all of the stocks in an index, but instead bars of gold.

 

As of mid-December 2004, the Australian Gold Bullion Securities (Australian Stock Exchange code GOLD) was holding 664 gold bars in London, totaling 267,359 ounces (8.32 tonnes), which had a net value of over US$110 million.  Each share of an ETF entitles its owner to 99.88% of 1/10th of one ounce of gold, after the fund had been operational for 10 months. That means each share, of which there are currently about 3 million, has a price of about AU$55 (US$41.50) at today's spot price.

A troy ounce, which is used to measure gold, is different from the more widely-used ounce (known as an avoirdupois ounce) that is used to weigh most other things.  One troy ounce amounts to 31.10 ounces, while the more familiar avoirdupois ounce is 28.35 grams, so a troy ounce is about 1.1 avoirdupois ounces.

The Web site http://www.goldbullion.com/ actually posts photos of the specific gold bars that comprise the underlying portfolio.  Each gold bar weights approximately 25 (regular old avoirdois) pounds or 11.5 kilos (to further confuse matters, a troy pound would contain 12 troy ouces as opposed to the 16 avoirdupois ounces in an avoirdupois pound).  Their weight is targeted at 400 troy ounces a bar, and is permitted to vary from 350 to 430 ounces a bar.  Below is a photo of some of the actual gold bars underlying the ETFs. 

 

As noted above, the launch in Australia presages a series of future launches worldwide, not only of bullion-based ETFs, which will certainly be launched in other countries, but also possibly of other commodity-based ETFs. S&P recently launched a new commodity index, for example, explicitly mentioning the possibility of an ETF launched on a broad, portfolio-stabilizing commodity index (which would exclude gold). Another possibility would include an ETF based on crude oil, for example.

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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