SPDR Gold Trust Thrives as Economy Fears Mount

The creators of the SPDR Gold Trust aren’t modest about what that fund has done to the investment landscape.

Before the World Gold Council started its exchange-traded fund, or ETF, in 2004, gold was treated by investors much like diamonds, paintings, or other collectibles, says Jason Toussaint, managing director at the council. Everyone acknowledged it was a valuable asset, but it wasn’t convenient to own or trade.

Packaging gold in the form of an ETF, which trades throughout the day like a stock, has transformed perception of the metal, Toussaint says: “We have financialized gold.” Now, notes Jim Ross, senior managing director of State Street Global Advisors (STT), which markets the fund, “If you want to express a view on gold, you can buy it just like you buy IBM.”

That’s made the gold market more volatile, says commodity trader Jeffrey Friedman, senior market strategist at brokerage Lind-Waldock in Chicago. Compared with even just five years ago, when the cost and price of trading gold made investors cautious, now “when data points come out that conflict with the theory you have as an investor, money travels in the blink of an eye and volatility no question has increased,” says John Stephenson, portfolio manager at First Asset Investment Management and author of “The Little Book of Commodity Investing.”

SECRET VAULT

In launching an ETF, the World Gold Council jumped on a hot trend -- the number of ETFs tripled from 2003 to 2006, according to the Investment Company Institute. The goal was simple. The council, comprising 22 gold mining companies that make up 60 percent of the world’s annual production, wanted to expand demand.

Unlike many commodity funds, the ETF holds gold in physical form. Investors in the ETF have filled a vault in a secret location in London with 1,210 metric tons, or $58.7 billion, of gold. That makes the trust, often referred to by its ticker, GLD, the largest commodity ETF in the world. Only four nations - - the U.S., Germany, Italy, and France --have more gold in their vaults, according to the council.

The fact that GLD shares are backed by bullion is a big part of its appeal. To invest in most other commodities, funds have to buy futures, financial instruments promising delivery of these commodities at a later date. The price of a commodity and its futures contract can differ, and even small differences can cost investors over the long term. With one-tenth of an ounce of gold behind every share, GLD tracks the price of gold closely. In 2010, GLD rose 29.3 percent; the spot price of gold rose 29.6 percent.

’PRECAUTIONARY INVESTMENT’

Gold performs an important function in a portfolio, as it tends to zig when other assets, such as stocks, zag. DundeeWealth Chief Economist Martin Murenbeeld believes investors have returned to a view of gold as a preserver of wealth that holds value independent of local currencies or central bankers. That’s a switch from the 1970s to ‘90s, when jewelers made up the vast majority of gold buyers, he says. Even though Murenbeeld is bullish on gold, he views it as a “precautionary investment” -- “put some gold in your portfolio and hope it doesn’t go up.”

That hope would’ve been dashed in recent years, as fears of inflation and economic instability have sent investors flocking to gold. An investor who held GLD since 2004 would’ve seen shares gain 232 percent, while the Standard & Poor’s 500-stock index rose 12.4 percent. A less pleasing period for gold investors was from September 1980 to August 1999, when gold’s price fell 62 percent. Over the same period, the S&P 500 rose 952 percent.

While a bar of gold in the bank may bring peace of mind, owners of GLD need a strong stomach. After the spot price of gold rose 10 percent in 2011’s first four months to an all-time high on Apr. 29 of $1,563.70 per ounce, it dipped 5.7 percent in the next four days. The recent volatility coincides with a 7 percent drop in the size of the trust, from 1,280 metric tons at the end of 2010 to 1,192 metric tons on May 17. GLD “introduces a more fickle group of buyers into the market who are just driven by sentiment,” says Stephenson.

EXCHANGE-TRADED NOTES

While GLD is the big man on campus, there are many other ways to invest in gold, including gold exchange-traded notes, or ETNs, which are debt securities that trade on an exchange. Paul J. Simon, chief investment officer at Tactical Allocation Group, uses GLD in client portfolios along with the iPath Dow Jones-UBS Commodity Index Total Return ETN (DJP), which tracks a broader index of commodities. Barclays Bank guarantees that the iPath ETN will get the same returns as the index.

A potential problem is that investors put all their faith in one counterparty, the bank backing the ETN, says Simon. Such concerns were heightened by the collapse of Lehman Brothers in 2008.

With GLD, the risk would be that the gold is not in the vault. GLD’s gold is stored by its trustee, HSBC Group. Every day, HSBC publishes the serial numbers of all the gold bars in its vault backing the ETF. Once a year, an accounting firm audits HSBC’s vault procedures, and twice a year an independent firm counts all the gold bars and weighs a random selection of them, says Toussaint.

MINING STOCKS

Another way to get exposure to gold is by owning stocks of gold miners, but the connection to the metal’s price is not as direct. Sometimes gold stocks can do better than gold, and sometimes they lag for years at a time. Plus, says First Asset’s Stephenson, there are other considerations when buying a stock, such as “Is management good?”

Volatility or not, investing in gold via ETFs is likely to grow. Since the start of 2007, the number of ETFs fully invested in physical gold has risen from seven to 18, and GLD rivals are springing up in the U.S., U.K., Germany, Turkey, Dubai, and India. GLD and other ETFs made up 9 percent of all gold purchases in 2010, according to the World Gold Council.

Such interest bolsters the argument that gold’s price will head higher as it becomes a permanent part of more portfolios. What an investment in a gold ETF likely won’t bring, as new investors and speculators jump in and out of the market, is peace of mind.

To contact the reporter on this story: Ben Steverman at bsteverman@bloomberg.net

To contact the editor responsible for this story: Suzanne Woolley at swoolley2@bloomberg.net

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