Given the popularity in ETPs that are physically backed by gold, this guide will supply investors with a framework for selecting the right vehicle. It is important for investors to understand the differences among gold ETPs to ensure that they select the right investment vehicle to meet their investment goals.
Gold: Why and how?
Gold has long been a popular investment because of its many attractive characteristics, including:
- Diversification benefits, thanks to low correlation to other financial assets
- Use as a hedge against unforeseen market events
- Ability to serve as a safe haven during periods of low interest rates
Chart 1: Gold ETP growth in the U.S.
Source: Bloomberg and Aberdeen Standard Investments, November 18, 2004 – April 30 2021. For illustrative purposes only.
There are several types of gold exposure in a portfolio, but the most familiar are:
- Holding physical bars or coins
- Investing in an ETP, which may be physically backed by gold
- Employing derivatives, such as gold futures
- Holding gold mining stocks
From the outset, the goal of gold ETPs was to lower the barriers of entry and provide investors with a convenient, cost effective way to access physical gold.
Five key considerations of physically backed ETPs
When it comes to investing in gold ETPs, we believe any due diligence process should include these five considerations:
While price or a fund’s expense ratio may factor heavily in the selection process for investors (rightfully so), there are other important factors that determine the cost efficiency of an ETP.
- Multiple Authorized Participants (APs) — these should be encouraged as they minimize the opportunity for a premium/discount to persist. They also reduce tracking error.
- Multiple Market Makers (MMs) — these should be encouraged as they provide liquidity, reduce spreads and encourage fair-value pricing.
2. Proven track record
Physically backed gold ETPs are unlike other products in the exchange-traded fund landscape. It is essential that investors carefully examine the track record and experience of the issuer.
It is paramount that all participants involved in the management of the product, including the trustee and custodian, are independent and have proven track records in their roles. In order for an exchange traded product to be successful, it must have liquidity. A quality product should be supported by a network of liquidity providers to ensure tight bid/offer spreads and an efficient creation/redemption process.
Gold ETPs should only deal in London Bullion Market Association (LBMA)1 approved London Good Delivery bars.2 This will provide the product with the security, reliability and strength needed to make investors sufficiently comfortable. The chosen custodian should be a member firm of the LBMA. LBMA member firms have secure facilities that meet high standards for security and storage.
Product liquidity has become synonymous with the trade-ability. The ability to trade easily is an important consideration in determining the differences between competing products. A more liquid product will allow for a more efficiently priced product.
All physical gold ETPs have similar access to the underlying gold, so the primary market impact of creating and redeeming ETP units should be identical. This is not the case when one looks at the secondary market liquidity.
Secondary market liquidity, especially liquidity displayed on exchange, can differ significantly between products. The key measures of liquidity are the bid/offer spread and the number of market makers.
- Bid/offer spread — the difference between the best price at which the ETP can be purchased and the best price it can be sold at any given moment.
- Market makers — Market makers compete to provide the best prices in the order book. The larger the number of orders, the more competitive the spread.
These measures combined lead to a more liquid product.
Gold ETPs should be backed by physical LBMA Good Delivery bullion and should be held in allocated accounts. Small amounts of unallocated gold may be held to facilitate operational ease.
- Audits and bar lists should be verifiable against the LBMA Good Delivery list
- Bullion should be stored with a custodian steeped in experience in bullion storage
- No lending of or leasing of the bullion should be taking place
- Cash or certificates should be used as a substitute for physical bullion
Due diligence checklist
When evaluating how to allocate to gold, we suggest that investors consider how well the vehicle they’ve selected meets the below criteria. Considering these factors may help investors make more informed decisions to meet their investment goals.
|Cost||Competitive management fee|
|Tight spreads and minimal tracking error|
|Multiple authorized participants|
|Multiple market makers|
|LBMA Good Delivery bars|
|Custodian is a member firm of the LBMA|
|Security||Fully backed by physical bullion|
|No lending or borrowing against the bullion|
|No credit risk to the custodian|
|Limited operational risk|
|Track record||Issuer has a long operating track record|
|Partners are highly experienced|
|Fund size is sufficient and has a diversity of investors|
|Transparency||All major counterparties are independent of the issuer|
|Easy-to-understand fee structure|
|Audit procedures are published, including at least one random
audit of the vault per year
|Daily publishing of the bar list|
1 The London Bullion Market Association is the primary global bullion market trading platform for gold and silver. It is an over-the-counter market that has established standards for production quality of metals transacted and settled within the market.
2 Good delivery refers to transfer of ownership of a security from a seller to a buy, with all necessary requirements having been met. The LBMA has specified good delivery criteria for physical gold that serve as a quality standard.
PAST PERFORMANCE IS NOT AN INDICATION OF FUTURE RESULTS. The statements and opinions expressed are those of the Aberdeen Standard Investments. All information is historical and not indicative of future results and subject to change. The reader should not assume that an investment in any securities and/or precious metal mentioned was or would be profitable in the future. This information is not a recommendation to buy or sell.
The Aberdeen Standard Gold ETF Trust is not an investment company registered under the Investment Company Act of 1940 or a commodity pool for purposes of the Commodity Exchange Act. Shares of the Trust are not subject to the same regulatory requirements as mutual funds. Commodities generally are volatile and are not suitable for all investors. Trusts focusing on a single commodity generally experience greater volatility. Please refer to the prospectus for complete information regarding all risks associated with the Trust. Shares in the Trust are not FDIC insured and may lose value and have no bank guarantee.
The value of the shares relates directly to the value of the precious metal held by the Trust and fluctuations in the price could materially adversely affect investment in the shares. Several factors may affect the price of precious metal, including:
- A change in economic conditions, such as a recession, can adversely affect the price of the precious metal held by the Trust. Some metals are used in a wide range of industrial applications, and an economic downturn could have a negative impact on its demand and, consequently, its price and the price of the shares;
- Investors’ expectations with respect to the rate of inflation;
- Currency exchange rates;
- Interest rates;
- Investment and trading activities of hedge funds and commodity funds; and
- Global or regional political, economic or financial events and situations. Should there be an increase in the level of hedge activity of the precious metal held by the Trust or producing companies, it could cause a decline in world precious metal prices, adversely affecting the price of the shares.
Also, should the speculative community take a negative view towards the precious metal held by the Trust, it could cause a decline in prices, negatively impacting the price of the shares. There is a risk that part or all of the Trust’s physical metal could be lost, damaged or stolen. Failure by the custodian or sub-custodian to exercise due care in the safekeeping of the metal held by the Trust could result in a loss to the Trust. The Trust will not insure its metal and shareholders cannot be assured that the custodian will maintain adequate insurance or any insurance with respect to the metal held by the custodian on behalf of the Trust. Consequently, a loss may be suffered with respect to the Trust’s metal that is not covered by insurance.
Investors buy and sell shares on a secondary market (i.e., not directly from Trust). Only market makers or “authorized participants” may trade directly with the Trust, typically in blocks of 50k to 100k shares.
Diversification does not eliminate the risk of experiencing investment losses.
Commodities generally are volatile and are not suitable for all investors. Carefully consider the Fund’s investment objectives, risk factors, and fees and expenses before investing. This material must be accompanied or preceded by a prospectus. Please read the prospectus carefully before investing.
Prospectuses for Aberdeen Standard Physical Gold Shares ETF, Aberdeen Standard Physical Palladium Shares ETF, Aberdeen Standard Physical Platinum Shares ETF, Aberdeen Standard Physical Precious Metals Basket Shares ETF and Aberdeen Standard Physical Silver Shares ETF
Steven Dunn is a registered representative of ALPS Distributors, Inc.
ALPS Distributors, Inc. is the marketing agent.
ALPS Distributors, Inc. and Aberdeen Standard Investments are not affiliated.