Nate Geraci
November 12, 2010
With Gold continuing to hit record highs, investors are increasingly aware of the benefits having gold in their portfolio. ETFs have become the cheapest and most convenient way for people to have gold exposure. It is important to know the various types of ETFs that give gold exposure and what the risks and benefits of each type.
There are four basic ways to get exposure to gold via an ETF:
Equity in gold companies – In times of rapidly rising prices, stock in gold-producing companies theoretically should outperform other investments because the companies can borrow to fully benefit from the leverage in the their business model. The equity, however, is also vulnerable to the trends in the entire stock market and, more importantly, bad management. The Market Vectors Gold Miners ETF (GDX) is the most widely held gold equity ETF.
Physical ownership –Two ETFs give you indirect ownership of the commodity itself. SPDR Gold Shares (GLD) and iShares COMEX Gold Trust (IAU) are the largest ETFs of this kind and are essentially the same ETF; both take physical ownership of gold bullion and a share of each represents a defined percentage of that gold. It is important to know that the IRS considers these ETFs to be collectibles, though, so all gains are taxed at a 28% tax rate.
Futures Contracts – The Powershares DB Gold ETF (DGL) gives exposure to gold via futures contracts. There are a few nuances to ETFs that use futures. First, price differences between futures contracts nearest their delivery dates and those with later deliveries can affect how closely the ETF tracks the price of gold. Second, since the fund uses futures contracts, all gains or losses – even unrealized – are taxed in the current year and all gains are taxed at a 60% short-term capital gains rate and 40% at a long-term rate. Because the ETFs frequently trade futures contracts, they can incur material capital gains and cause a major tax hit in a taxable account.
Exchange Traded Notes – Exchange traded notes, or ETNs, are actually bank obligations whereby the bank promises to pay back an amount at a future date that is equal to the return of a particular index. E-Tracs UBS Gold ETN (UBG) track an index that attempts to replicate the performance of futures contracts. Since it is an ETNs, which currently are treated as ‘prepaid contracts’ by the IRS and are therefore subject to 15% capital tax treatment, they are much more tax friendly (though the IRS can change its treatment at any time) than other Gold ETFs. The catch is they are actually bank obligations of the issuer (unsecured debt), so if they go out of business, you must get in line at the bankruptcy court to get your money back. In addition, many ETN’s are not very liquid.
