Gold Exchange Traded Commodities (ETFs/ETCs) have become an increasingly popular way for investors to own gold, and their number has proliferated since their launch of the first gold ETC in 2003 – but not all are built alike. This article provides a framework for gold investors to compare the different types of gold ETFs and judge whether a gold ETC is ‘best in class’. For investors to reach their intended goals, it’s important for them to understand the different structures and approaches that gold ETFs take.
There are five key areas for investors to question when performing due diligence on a gold ETF:
- Security
- Transparency
- Efficiency
- Quality of the physical gold holdings
- Experience of the manager and service providers
Security
- Is the ETF 100% backed by physical gold?
- Are there mechanisms in place to avoid physical gold being substituted for cash or securities within the product?
- Is the physical gold London ‘Good Delivery’ standard and verifiable against the ‘Good Delivery’ database?
- Is the gold stored in a vault that is highly secure and trusted?
- Does the custodian segregate your gold from other assets they hold?
- There should be no counter-party risk from the issuer, custodian or any other participant.
Transparency
Investors deserve certainty when they purchase a gold ETF. This means knowing which companies are involved in the management, trading, custody and administration of the ETF, the specific gold bars held by the ETF and the checks and audit processes that are in place. Costs and charges associated with the ETF should also be easy to understand.
- Are bullion holdings and identifiers published and updated daily?
- Is it clear who is the issuer, trustee, custodian and liquidity providers?
- Are there any potential conflicts of interests or are counter-parties independent of each other?
- Are the fees easy to find and is it clear what their impact on the NAV is?
- Is the issuer’s account audited by an assayer who is LBMA approved?
- Does the audit process include a semi-annual vault inspection that compares the actual gold holdings to the records?
Efficiency
A competitive liquidity environment helps lower the cost of buying and selling a gold ETC. Gold ETFs should be supported by a liquidity network of experienced Authorised Participants (APs) and Market Makers (MMs). Competing for business helps reduce arbitrage and premiums in the market and ensures the price of the ETF consistently tracks the price of gold. Multiple trading counter-parties also help lessen operational risk in the event of failure of an individual liquidity provider to participate in the market.
The ETF should not limit, cap or restrict the quantity of physical gold that can be delivered. Physical delivery should be 'London Good Delivery' bars. Delivery of gold should occur in a T+2 framework to an LBMA approved account. An investor should be able to redeem 100% of their gold for cash in a single trade and at a reasonable cost.
Quality of the Physical Gold Holdings
To ensure a secure and reliable product, the ETC should be physically backed by ‘London Good Delivery’ bars. These bars ensure the bullion can be sold in the London OTC market.
The most secure gold ETFs should always have over 100% of the ETF covered by physical gold. This is usually achieved by the Issuer having an extra bar to ensure that where a redemption results in a fraction of a bar being left so having a spare bar means there will always be 100%+ gold.
Experience & Track Record
Operating in the OTC gold markets requires a degree of expertise and experience. When investors are selecting a gold product, they should have confidence that the issuer and counter-parties supporting the ETC have strong, proven track records and understand the mechanics of the gold market. Counter-parties and service providers like custodians, trustees and registrars and liquidity providers should also have a proven track record in gold and be independent of each other.
View part five of the Investor’s Guide to the Gold Market and Gold ETCs and find out about 'The Royal Mint Physical Gold ETC'.
Visit The Royal Mint Responsibly Sourced Physical Gold ETC Fund Page to learn more about RMAU.