Cover Story

www.etfiasia.com

The ETF industrys strategic gold mine?

Precious metal forms a natural part of most global investment portfolios
By Imran Ahmed*

billion of capital losses associated with golds price decline and GLD assets have dropped over 40% to $39.2 billion. Even at $39 billion, GLD scores at number five in the league tables of ETFs ranked by AUMs. After facing similarly substantial outflows, IAU had respectable AUMs of $6.9 billion as at July 1, 2013. The introduction of gold ETFs has changed the investment landscape for gold. ETFs such as GLD and IAU have made it easier for small retail investors, without large investable sums to invest in gold. As gold ETFs trade like stocks, the minimum investment sum has been reduced. Odd lots can be purchased, regular investment programs can be implemented and transacting in gold is as easy as transacting in the common stock of IBM, Coca Cola or any other listed share. Also, gold ETFs have significantly improved the operational ease for making investments in gold, thereby widening the group of investors able to evaluate gold as an investment option. As Frank Henze, the managing director and head of SPDR Exchange Traded Funds, Asia Pacific, suggests: The availability of gold ETFs has meant more investors have access to gold in a way that they may not have had access in the past or were shying away from gold because of the high cost of transacting in a physical form.

Cost issues
ETFs furnish a gold price tracking mechanism at a reasonable cost. Whereas purchasing physical gold bars or coins typically involves costs associated with delivery, storage and insurance, purchasing gold ETFs provides an all-in-one solution. Unlike some other commodity ETFs which rely on derivative contracts to track the price of the underlying product, GLD and IAU purchase (and sell) physical stocks of gold to support the creation and redemption of shares in the respective funds. Hence, in order to support GLD shares, each NAV Basket of $12,832,307 has an underlying of approximately 9,659 gold ounces. GLD and IAU, with total expense ratios of 0.40 and 0.25% respectively, remove the operational hassles of gold delivery, storage, etc. for all classes of investors, i.e. asset managers, central banks or simple retail investors.

G
6

old has become a big part of the ETF universe since the advent of ETF products in the early 1990s. The gold ETF sector comprises of at least 20 different ETFs, including leveraged, inverse and gold mining related ETFs (see Table 1). However, the two largest straight gold ETFs are the State Street Global Advisors SPDR Gold Shares ETF (GLD) and the iShares Gold Trust (IAU).

GLD, currently the largest global gold ETF, was launched almost 10 years ago in November 2004. The IAU was launched a few months later, in January 2005. Until recently, GLD was the second largest ETF in the world. At the start of 2013, GLD had assets of US$72 billion. However, since the beginning of the year, GLD has suffered net outflows of approximately $20 billion. Add on approximately $19

ETFI ASIA 2013 Q3

Cover Story
www.etfiasia.com

Still, there are many old fashioned gold bugs that prefer to purchase physical gold and often express scepticism about owning gold paper certificates, including ETFs. However, the sponsors of GLD (and other gold ETFs) dismiss such criticism. According to them, these ETFs have adequate protections in place to ensure investor interests are safeguarded. These include independent semi-annual audits of all GLD gold bars. These audits not only weigh all gold bars but also measure the golds density to ensure the quality of gold is in line with the proscribed requirements of the London Bullion Market Association (LBMA). All the bars are catalogued and the information is made public regularly. GLDs Daily Gold Bar list and Inspectorate Certificates are available on the SPDR Gold Shares website. ETFs like GLD and IAU, which create underlying portfolios of the relevant commodity, may provide superior tracking error relative to ETFs which rely on derivative structures but how have these gold ETFs fares during the last 12 months a period of high volatility for the gold price? During the period, the spot gold price, as measured by the London PM fix, has fallen by over 25%. Year-to-date, the drop has been even more dramatic at slightly more than 28%. Moreover, due to large scale redemptions the average traded value of gold ETFs has also risen during the period. According to SSGA estimates, GLD presently trades an average of approximately $2 billion in value daily. In spite of the spike in volatility and trading volumes, the two main gold ETFs, GLD and IAU, have performed admirably well in both short- and long-term periods (see Table 2). However, the recent large movements in the spot gold price has forced investors to accept larger bid and offer spreads, manifested in the form of a discount or premium to the Net Asset Value (NAV) of the respective ETF share. In the second quarter 2013, GLDs price discount / premiums were over 1% for almost one third of the second quarters 64 trading days, i.e. GLDs midpoint of the closing bid / ask price was at a premium / discount of 1% or more in comparison to the ETFs calculated NAV for a total of 21 trading days. During this period, IAU also demonstrated a

heightened level of trading at a premium / discount to its NAV. IAUs greatest price premium and discount was 3.45 and -3.08%, seen on June 28 and April 12 respectively. For some investors, particularly large institutions such as central banks or alternative investment funds, the increased bid and offer spread represents an additional trading cost, which must be factored into any decision to invest in ETFs.

Market risk
In defence of the pricing structure, SSGAs Mr. Henze believes the pricing mechanism functions well even in times of extreme movements such as during the last 12 months: The price the fund [GLD] trades at also reflects the market risk. So in times of higher volatility and higher uncertainty obviously the risk increases and therefore the spread an investor pays for a product increases. The risk is factored into the price quoted. That is entirely normal and is a function of the market. The fate of gold and gold related ETFs is intertwined with the spot price

of gold. During golds recent decade plus bullish run, gold ETFs were all the rage. As the gold price rose, gold ETFs sucked in money such that the SPDR GLD closed 2012 as the second largest ETF in AUM terms. However, as golds price dropped during the last twelve months investors redeemed holdings from gold ETFs with a vengeance. According to the latest research from BlackRock, the PreciousMetals and Gold category of ETFs saw net outflows of $30.8 billion in the seven months of January to July 2013. The redemptions left the category with AUMs of $83.7 billion at the start of August. Despite recent negative fund flows, gold forms a natural part of a sufficient number of global investment portfolios to merit a healthy future for the gold ETF sector. In addition, gold ETFs have yet to deeply penetrate traditional gold heavy geographies such as China and India, where domestic precious metals ETFs are only just beginning to see the light of day. Clearly, unlike many specialised niche ETFs, gold ETFs will form a mainstay for the ETF industry for years to come.

Table 1: Sample Gold and Gold Related ETFs

Ticker
GLD IAU DGL GDX PSAU NUGT DZZ UGLD

Name
SPDR Gold Shares iShares Gold Trust PowerShares DB Gold Fund Market Vectors TR Gold Miners ETF Powershares Global Gold and Precious Metals Portfolio ETF Direxion Daily Gold Miners Bull 2x Shares ETF Powershares DB Gold Double Short ETN VelocityShares 3x Long Gold ETN

Launch Name
November 18, 2004 January 21, 2005 January 5, 2007 May 16, 2006 September 18, 2008 December 8, 2010 February 27, 2008 October 14, 2011

AUMs
37.1B 6.8B 165.4M 6.8B 18.4M 406.0M 94.5M 34.1M

Source: Yahoo! Finance. Accessed on August 15, 2013.

Table 2: GLD and IAU Performance Summary

ETF
GLD IAU Gold

Name
SPDR Gold Shares iShares Gold Trust London Gold PM Spot Fix

YTD
-28.5% -28.4% -28.1%

1 Month
-14.6% -14.5% -14.5%

1 Year
-25.7% -25.6% -25.4%

3 Year
-1.8% -1.7% -1.4%

5 Year
4.7% 4.9% 5.1%

Source:  GLD and IAU performance from respective websites accessed on August 15, 2013. Gold London PM fix from GLD website accessed on August 15, 2013.

ETFI ASIA 2013 Q3