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Commodity ETFs

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Gold has started the New Year on an excellent note, reaching its one month high, though well off of its August 2011 high of ~$1900 per ounce. Later last year, the yellow metal had lost some of its luster but still closed the year up, for the eleventh year in a row.

Short term factors that resulted in recent rally include rising appetite for gold in China, as the investors seek to protect their wealth against falling property prices and rising inflation. The demand in China is also usually highest before the Chinese Lunar New Year (beginning January 23). Consumer demand for gold improved in India in the last few weeks due to Indian currency’s rise against the dollar (making gold imports cheaper) and beginning of the wedding season.

Some of the factors that will likely support gold’s upward trend in 2012 are rising inflationary expectations and heightened macroeconomic uncertainty in many countries. Continued increase in money printing by the central banks in many countries led to rise in inflationary expectations in many countries. Gold acts an inflation hedge and store of value. Macroeconomic uncertainties in most parts of the world lead to rise in investors’ interest in safe haven assets like gold. Gold also benefits from the lack of investment alternatives for the official reserves managers as the US treasuries are too expensive and euro-zone bonds are risky. The foreign exchange reserves are primarily invested in top rated fixed income assets and gold and over the last few years the Central banks of developing countries have been increasing their holdings of gold as the reserves have been increasing while not many eligible investment instruments are available now. 

On the other hand, slowdown in China and India will impact the demand this year. India has traditionally been the largest consumer of gold but was overtaken by China last year. Both together account for about 40% of annual global gold consumption. Also, US dollar and gold usually move in opposite directions. A strengthening US dollar can pressure gold prices.

Whatever be the direction of gold in 2012, gold should be a part of a diversified investment portfolio. Buying physical metal provides direct exposure to the asset class but comes with its own problems while the gold ETFs provide a cost efficient and secure way to invest. (Read Create a Diversified Portfolio Using ETFs)

SPDR Gold Trust (GLD - ETF report)

GLD is the largest, most liquid and widely traded gold ETF. It seeks to replicate the performance of the gold bullion net of expenses and each share represents 1/10th of an ounce of gold. The fund is backed by physical holding of gold bullion in London vaults. Gold is sold on an as-needed basis to pay the Trust's expenses and as a result, the amount of gold represented by each share will be reduced over time. This ETF has an expense ratio of 0.40% per year

iShares Gold Trust (IAU)

IAU presents a much cheaper option to GLD with its expense ratio at 0.25% per year. Each share of IAU represents about one 100th of an ounce of bullion. The shares are backed by gold, held by the custodian in vaults in the vicinity of New York, Toronto, London and other locations. Though more expensive, GLD has ten times the assets invested and is thus much more liquid than IAU, resulting in slightly lower bid-ask spreads.

ETFS Physical Swiss Gold Shares (SGOL - ETF report)

SGOL is a relatively new product in this space, started in September 2009. Its main selling point is that its gold bullion is held in the vaults of Zurich, Switzerland. Like GLD, each share of SGOL represents 1/10th of an ounce of gold. But compared to GLD and even IAU, it is much less liquid, which may be reflected in high bid-ask ratio. With an expense ratio of 0.39% per year, SGOL does not offer any cost advantage also. So, unless you are worried about any risk to the safely of gold held in New York or London vaults, there is no reason to prefer SGOL over the other two.

 

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