Understanding Gold & Silver ETF's

If you are just starting to introduce yourself to the gold and silver markets, you may wonder if a gold or silver ETF might be a good place to invest. In earlier articles, we looked at other ways people people invest in gold and silver. The article Understandng the US Mint focused on some basic information about the physical bullion coins produced at the US Mint. Understanding Mining Stocks looked at some important factors to consider in evaluating a potential investment in mining company stocks.

In this article, we will talk about another way some people invest in gold and silver, the ETF's (Exchange-Traded Funds). We'll use a Q&A style format to offer same basic information about these funds and how they are perceived by experienced gold and silver investors.

Q: What is a commodity Exchange-Traded Fund?

A: Here is a definition from Investopedia:

"A commodity ETF is an exchange-traded fund (ETF) invested in physical commodities, such as agricultural goods, natural resources, and precious metals. A commodity ETF is usually focused on either a single commodity—holding it in physical storage—or investments in futures contracts. Other commodity ETFs look to track the performance of a commodity index that includes dozens of individual commodities through a combination of physical storage and derivatives positions."

Keep in mind that ETF's are not all alike. As explained in the definition above, some hold actual physical metal in storage while others may hold various nonphysical forms of the metals. This distinction may matter to an investor, so it is important to understand how the ETF works in that regard. We will look at a few of the major gold and silver ETF's and provide links to research how each one works.

Q: How is an ETF different from owning actual physical gold or silver?

A: Owning actual physical gold or silver usually is viewed as owning a physical form of the metal you can hold in your hand. That could be coins, bars, or generic forms of the metal called "rounds" that have a coin like appearance, but are not coins made by a government mint. A commodity ETF is more like owning shares of stock, except the shares represent gold or silver instead of a corporation like Microsoft or IBM. Some ETF's insist on owning actual physical metal to back each share issued while others may own a combination of actual metals combined with various kinds of "paper promises" for the actual metals. Most people who invest in a commodity ETF are wanting exposure to the market price of gold and silver and not physical possession of the actual metals. Some hedge funds and pension plans are allowed to buy ETF's but not actual metals, so they tend to use an ETF to invest in exposure to the price of gold or silver. ETF's may sell some of their metal assets to pay fund expenses. Investors should research the fund fees.

Q: Who are some major gold and silver ETF's?

A: We will look at a couple of gold ETF's and a couple of silver ETF's in this article. There are many more to choose from however, as you can see from this article on etf.com. For gold, we will look at GLD and IAU. For silver, we will look at SLV and PSLV. Investors should know that there is a lot of debate on the question of whether ETF's actually own physical metal to back up their issued shares. Here, we will link to the four ETF's mentioned and let readers do their own research on that topic. Some investors may not be concerned about this issue and others may be very concerned about it. Generally speaking, investors should not view an ETF as easily exchangeable into actual physical gold or silver if that is what they want to own. Some, such as PSLV, do allow for redemption of actual metal, but even they offer to redeem for metal "subject to certain minimum requirements". Most ETF investors are looking for exposure to the price of gold or silver which these funds try to mimic in their share price. Some ETF's do trade options contracts for those who like to use options for more leverage.

Q: Where can I find some basic info on GLD?

A: The prospectus is a good source. Most people don't read them. But anyone making a significant investment should learn as much as they can and a prospectus is one good place to do that. Here is a Factsheet that offers a summary overview. Here is the stated objective of the fund from the Factsheet:

"The investment objective of the Trust is for SPDR® Gold Shares (GLD®) to reflect the performance of the price of gold bullion, less the Trust's expenses."

Q: Where can I find some basic info on IAU?

A: Here is the prospectus and Factsheet. iShares  offers this summary information page on their web site where they state this fund objective:

"The iShares Gold Trust (the 'Trust') seeks to reflect generally the performance of the price of gold."

Q: Where can I find some basic info on SLV?

A: Here is the prospectus and Factsheet. iShares  offers this summary information page on their web site where they state this fund objective:

"The iShares® Silver Trust (the 'Trust') seeks to reflect generally the performance of the price of silver."

Q: Where can I find some basic info on PSLV?

A: Here is the prospectus and Factsheet. Sprott offers this summary information page on their web site. Their Factsheet states this goal for the fund:

"The goal of the Sprott Physical Silver Trust (the “Trust”) is to provide a secure, convenient and exchange-traded investment alternative for investors who want to hold physical silver."

You can see the difference between PSLV and the other three funds by looking at their stated goals and objectives. PSLV talks about holding physical silver while the other three talk about reflecting the price of gold and silver.

Q: Is a gold or silver ETF the best way to invest in this sector?

A: Each person has to decide that based on their own situation and personal objectives. This blog does not offer investment advice. If someone wants to own actual physical metal, they will likely not use an ETF to do that. If they are looking for a way to have exposure to the price of gold or silver, they might choose an ETF to do that. Another option some may consider is a kind of middle ground between those two options which is to buy physical gold or silver and have someone else vault it for them. One Gold is an example of that kind of option. You own actual physical metal, but don't hold it in your hand (unless you choose to redeem your account value for actual metal and have it shipped to you). Using your online account, you can buy and sell your gold or silver online as well. So you can trade it like you can shares of an ETF. Most people would not use One Gold to short term trade, but might trade with it over a longer term.

Experienced gold and silver investors tend to diversify within the sector by using two or more of these various options. They may hold actual coins or metal as a form of insurance. They may own some gold and silver vaulted for them by some one else they can more easily sell or trade quickly. If they want to trade or speculate on prices, they may use an ETF (or options on an ETF) to do that. So, the answer to this question depends on what the investor's objectives are. A goal for some is to hold physical gold and silver long term as hard assets as part of a diversified overall portfolio and then to sub diversify within the gold and silver part of the portfolio. Obviously, this will vary with each person and the amount of investment funds they have.

Q: What form of investment in gold and silver is most likely to have an impact on the price of gold and silver?

A: In my view the price of gold and silver is more impacted by the purchase of actual physical gold and silver. This is because it is possible to create a large supply of "paper gold or silver" based on various kinds of derivatives that do not have to relate to how many ounces of actual physical gold or silver are being demanded in the physical market. For supply and demand to function in this market to put upward pressure on the price, there must be more demand for actual physical metal than the available supply of real metal at the current market price. This is proven all the time when demand for actual gold or silver products (such as coins in the retail market for example) puts upward pressure on the price and it moves well above the price quoted for the paper futures contracts. Also, if someone like Apple needs real silver to make their products, that is true physical demand and not speculative demand which may be the case with a futures contract. A futures contract owner often just settles for a cash payment. Someone like Apple has to have real silver.

Conclusion

Gold and silver ETF's are one way to invest in gold or silver, but tend to relate more to speculation on price movement than on owning actual gold or silver. Potential investors should assess their own personal objectives and then select the investment option that best helps them meet their objectives. This will obviously vary for each person. The investment option most likely to impact gold and silver prices is buying actual physical forms of the metals in my view. 

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