Gold is the new gold
How ETFs can provide exposure to physical gold
You may have heard over the past few years that “crypto is the new gold,” but as the recent volatility in cryptocurrencies has proven, the truth is that there is no replacement for gold. There is a reason why central banks and investors alike consider gold an important asset to own. Gold is among a small number of assets that serve both as a store of value with a long history of use as a currency and as a commodity with a large consumer and industrial demand base.
The golden rule
Gold is one of the most amazing metals on the periodic table. It never rusts or corrodes, and it is an excellent conductor of electricity and is easy to work with. These properties make it invaluable in many technological applications, such as smart phones, and – along with its value – are why it is also used so widely in jewellery.
While this may seem to hold little relevance to a modern investment portfolio, the demand these sources represents is actually a big reason for the yellow metal’s ability to store value.
According to the World Gold Council, jewellery and technology accounted for nearly 64% of global demand in 2021. That puts a very significant floor under the price of gold and reveals that a large part of the value of gold is found in its own future demand for these uses, which are unrelated to currencies or financial markets.
Finding gold after the rush
What is the best way to invest in physical gold? Besides heading to the Black Hills, looking for lost mines in British Columbia, or digging for buried treasure on Oak Island, buying gold bullion directly is the most obviously answer. But that presents challenges, ranging from sourcing to additional costs, like storage and insurance. These amounts can be significant and likely make this one of the most expensive options for smaller portfolios.
Gold derivatives, like futures or options, while much more cost effective, are complex trading instruments that many investors do not have access to.
That leaves exchange-traded funds (ETFs). For the average investor, they will be the most cost-effective option for investing in gold. In addition, they offer the advantages of being widely available and extremely liquid. While they may not represent direct ownership in the precious metal, some gold ETFs are fully backed by physical gold. That means for each unit of the ETF, the fund owns a certain amount of gold. The result is an ETF that closely tracks the price of gold less its management fee.
The benefits of gold ownership through ETFs is also recognized by institutional investors. As of June 30, 2022, 170 Canadian investment funds maintained an allocation to gold – ranging from very small to well over 30%. Of those, over 80% gain at least some of their gold exposure through ETFs.
Two popular Canadian gold-backed ETFs are the iShares Gold Bullion ETF (TSX: CGL), launched in 2009 with a 0.55% MER, and Purpose Gold Bullion Fund (TSX: KILO), which debuted in 2018 and has a 0.23% MER. As Chart 1 shows, both funds have maintained the value of invested dollars throughout the pandemic – a period that saw unprecedented monetary intervention by global governments. Conversely, the negative outcome of those policies is reflected in the decline of currencies like the Canadian and U.S. dollars against the value of gold.
Over the past three years the Canadian dollar has lost 9.9% with respect to gold, while the U.S. dollar has lost 11.2%. In the same period, KILO and CGL have maintained the relative purchasing power of invested Canadian dollars.
Too much of a good thing
Historically a gold allocation of 5% has been typical of diversified portfolios, but a recent paper by the World Gold Council titled “The Relevance of Gold as a Strategic Asset 2022” looked at this question in more depth. They found an optimal allocation for the U.S. closer to 8%. We can use a similar value for Canada and look at the impact on two portfolios in Table 1.
The portfolios are rebalanced quarterly and returns over a three-year time frame are presented. In the case of the Canadian Dividend Portfolio, volatility is reduced by 10% and returns by 5%, increasing the risk-adjusted return by 5%. Similarly for the Global Balanced Portfolio, volatility is reduced by 9% and returns by 3%, resulting in a risk-adjusted return increase of over 6%.
While looking at a relatively short time frame, this example demonstrates how an allocation to gold can create a significant reduction in volatility and improve risk-adjusted performance in a variety of portfolios. Speak to your advisor about the role gold backed ETFs could play in your portfolio.
John Krisko, CFA, BBA, is Manager, Analytics & Data at Fundata Canada Inc. and is a member of the Canadian Investment Funds Standards Committee (CIFSC).
Notes and Disclaimers
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Commissions, management fees, and expenses all may be associated with exchange-traded fund (ETF) investments. Please read the simplified prospectus before investing. ETFs are not guaranteed and are not covered by the Canada Deposit Insurance Corporation or by any other government deposit insurer. There can be no assurances that the fund will be able to maintain its net asset value per security at a constant amount or that the full amount of your investment in the fund will be returned to you. Fund values change frequently and past performance may not be repeated. The foregoing is for general information purposes only and is the opinion of the writer. No guarantee of performance is made or implied. This information is not intended to provide specific personalized advice including, without limitation, investment, financial, legal, accounting or tax advice.