AFR ETF series: gold

Smart Money, Australian Financial Review, May 2011

On May 4, BetaShares launched a new exchange-traded fund (ETF) over gold. They’re not the first to do so, but this represented a significant and interesting step for the development of ETFs in Australia.

Why? After all, there are plenty of ways to invest in gold already. One can buy bullion itself – in certificates, bars or coins – through the Perth Mint. One can buy gold funds, or get exposure through listed gold miners. And there is already a gold ETF, called ETFS Physical Gold – previously Gold Bullion Securities – which tracks the price of gold.

The significance of the new one is that it is hedged, and this has become quite a big issue in Australia because of the rise of the Australian dollar. Investors in gold in, say, the USA have had a windfall: the price has more than doubled in the last five years, delivered better than 20% returns in 2005, 2006, 2007, 2009 and 2010, took out previous all-time highs earlier this year and is now hovering around US$1500 per ounce, even following a recent tumble.

The problem is, gold is quoted primarily in dollars, and during the same period the Australian dollar has risen dramatically against the US currency, eroding much of the precious metal’s gains for Australian investors. And this is not a new trend: BetaShares reckons that over the last 10 years, hedged gold has beaten unhedged gold by 5% a year.

The new BetaShares product keeps the currency out of the equation, while the existing gold fund, from ETF Securities, does not hedge for it.

There is, though, another side to this (gold) coin. The Australian dollar has had an extraordinary run, but at US$1.10 per A$, strategists have started to think the currency has run as far as it can and, in the long term, is likely to retreat some distance. If that happens, then the trend that has penalized the ETF Securities products suddenly benefits from it and it becomes a bonus. It all depends on what one’s view of the currency is, and whether one wants any exposure to it.

A future column in this series will look in more detail at the impact currency movements have had on ETF prices in Australia.

Either way, gold has become increasingly popular as an asset class. It is seen as a hedge against inflation, which in Asia Pacific in particular is becoming an increasingly important attribute. People like it because it performs well in stock market downturns, although in recent years it has performed exceptionally well (in dollar terms) as stock markets have gone up. It also acts as a diversifier, since it is uncorrelated with other asset classes. And there is the long-standing argument that there is a finite amount of it in the ground, and as we run out of gold to mine, the price must go up (although, unlike oil, once gold is mined, it sticks around pretty much forever in one form or another).

ETFs are one of the easiest ways to play gold. “Purchasing gold companies as a means to access the gold price introduces company and stock market risk, the futures market can be complicated and difficult to access, and direct ownership involves substantial insurance and storage costs,” says Drew Corbett, head of investment strategy and distribution at BetaShares. “A hedged gold ETF is the most pure and simple way of gaining exposure to movements in the price of gold.”

Both the BetaShares and ETF Securities products are backed by real physical gold – for example the ETFS one is backed by allocated metal held by its custodian, HSBC Bank USA, and can tell you if necessary where the bars are and provide copies of independent inspections. Both are cheap too: ETF charges 0.4% per year, BetaShares 0.49%.

Whether this is a good time to buy gold at all is a different question. You will find gold bulls who think the only way is up and gold will hit $4,000; you will find others who think we are well into a gold bubble and that when it pops, the price will halve.

It’s worth remembering, though, that much of the gold price increase in the last 12 months is really a reflection of the collapse of the US dollar. “The price of gold in, say, Australian dollars or Swiss francs actually isn’t much changed from a year ago,” says Richard Cookson, global chief investment officer at Citi Private Bank. “Indeed, dollar investors would have been better off so far this year simply buying euros, since the euro price of gold has fallen.” The question of whether there’s a bubble looks different, Cookson says, “if you look at the price of gold in a currency which, unlike the dollar, has been a little firmer than a wet sponge.”