The average investor is aware of the potential of gold as a hedge against inflation and geopolitical turmoil. Gold returned 7.65% per year between 1971-2018 according to the World Gold Council data. This makes owning the yellow metal an intriguing and steady return engine for investors. However, the purchase of gold bullion can be a little more difficult for these speculators.
Market participants have been aware of the trials of the retailer and in 1973 Wells Fargo and the American National Bank both launched index mutual funds in 1973 to bring passive investing to the masses. Mutual fund legend John Bogle would follow in 1975 with the launch of the first public mutual fund which tracked the S&P 500. The Exchange Traded Fund (ETF) was launched in 1989 and when State Street Global Investors released the S&P 500 Trust in 1993 (SPY) the world of investing was forever changed.
Commodities were a natural area were passive investing managers were looking to gain exposure for the average investor. Gold was an area of intense demand for passive investors given its hedge to stock downturns. This has led to the creation of numerous gold ETFs. We are going to look at the two largest, the SPDR Gold Trust (GLD) and the iShares Gold Trust (IAU) to see which vehicle presents the better opportunity for investors.
The first thing an investor must understand about a commodity ETF is the backing assets that present the Net Asset Value (NAV). The NAV is the value of a mutual fund or ETF that is reached by deducting the fund’s liabilities form the market value of all its shared and then dividing them by the number of shares. This is key for knowing what you purchase. A perfect example of not understanding the underlying assets was recently delivered to the market in the form of the United States Oil Fund (USO). This fund tracked the price of oils by purchasing crude oil contracts. Fund managers would have to roll the backing asset (in this case oil contracts) each month to maintain the desired exposure. This was a game oil traders picked up on and would use to pressure the fund around rollover dates. This caused unnecessary volatility in the USO and presented a never-ending downward pressure. Commodity investors need to be aware of this backdrop and to do that one has to look at the ETF prospectus.
We will first look at the GLD. The investment objective of the Trust is for the Shares to reflect the performance of the price of gold bullion, less the expenses of the Trust’s operations. The second part of that statement is key as investors need to be aware of the expense ratio for an ETF. We will discuss this shortly. The Shares trade on the NYSE Arca and provide institutional and retail investors with indirect access to the gold bullion market. In determining the NAV of the Trust, the Trustee values the gold held by the Trust on the basis of the price of an ounce of gold as determined by the afternoon session of the twice daily determination of the price of an ounce of gold which starts at 3:00 PM London, England time and is performed by participants in a physically settled, electronic and tradable auction administered by the IBA. The Trust’s only recurring fixed expense is the Sponsor’s fee which accrues daily at an annual rate equal to 0.40% of the daily NAV. The question you are probably asking yourself is Why should I pay this expense ratio? The reason is simple. The sponsor expects that , for many investors, costs associated with buying and selling the Shares in the secondary market and the payment of the Trust’s ongoing expenses will be lower than the costs associated with buying and selling gold bullion and storing and insuring gold bullion in a traditional allocated gold bullion account. All this information can be easily taken from the ETF prospectus.
Next up is the iShares Gold Trust (IAU). This fund offers exposure to one of the world’s most famous metals, gold. IAU is designed to track the spot price of gold bullion by holding gold bars in a secure vault, allowing investors to free themselves from finding a place to store the metal. The Trust seeks to reflect generally the performance of the price of gold. The Trust seeks to reflect such performance before payment of the Trust’s expenses and liabilities. On each day on which NYSE Arca is open for regular trading, the Trustee determines the NAV as promptly as practicable after 4:00 p.m. (New York time). The Trustee values the Trust’s gold based on that day’s LBMA Gold Price PM. If there is no LBMA Gold Price PM on any day, the Trustee is authorized to use the most recently announced LBMA Gold Price AM unless the Trustee, in consultation with the Sponsor, determines that such price is inappropriate as a basis for evaluation. The Sponsor’s Fee is accrued daily at an annualized rate equal to 0.25% of the net asset value of the Trust and is payable monthly in arrears.
Which is the better asset vehicle to invest? The underlying valuations for both ETFs is gold bullion so, theoretically, they should track closely in terms of performance and returns. Both ETFs are viewed as passive index-based performers meaning volatility should be relatively low. Neither ETF pays a dividend yield. The GLD is lightly older as it was launched in November of 2004 compared to January of 2005 for the IAU. The GLD is the most popular gold ETF with $50 bln in assets under management (AUM) compared to $17 bln in the IAU. Shares outstanding of GLD are 370 mln compared to 1.44 bln for the IAU. Average Daily Trading Volume is 12.5 mln for the GLD and 20.9 mln for the IAU. This means that the IAU is the more liquid of the two funds which can be key in times of risk as it is easier to exit one’s position in the IAU. The key variable is the expense fees which GLD sits at 0.40% while IAU is lower at 0.25%.
Does that 15 bps difference come into play on returns on investment? Looking at the two funds performances we see that the YTD returns are 11.81% for the GLD compared to 11.86% for the IAU. The 1-year returns are GLD 32.71% vs IAU 32.84%; 5-year GLD 7.16% vs IAU 7.33% and the 10-year GLD 3.31% vs IAU 3.46%. As we can see, the IAU is able to slightly outpace the GLD in returns due largely to its more favorable expense ratio. The expense ratio is an ongoing headwind for those trying to track gold spot prices. The annual fees slowly lower the NAV of the ETF, thus slightly reducing the amount of gold that a share is worth each year. The fee is relatively modest when compared to the fees charged for physical storage and insurance for smaller investors looking to directly hold their own gold bullion.
Looking at the side-by-side comparison both funds are well-managed and do a good job at tracking gold bullion which is its primary job. The primary difference is the expense ratio which provides IAU with a slight advantage which is evident in the running rate of returns. For investors who are watching every penny as they prepare for retirement this should be the deciding factor. But the expense fee wars are expected to pick up to attract market share. This phenomenon was recently witnessed in the online brokerage account commission fee wars which saw Charles Schwab run to $0 commission fees on trades which prompted competitors to follow suit. Investors would be paying close attention to these battles. If the trustee is capable of tracking gold bullion effectively, the biggest differentiator on a rate of return should continue to be the expense fee.