Gold ETFs: All You Need to Know

Most investors focus the bulk of their portfolios on three different asset classes: stocks, bonds, and cash. Yet even though you can be successful by concentrating in those areas, some investors prefer to add greater diversification by adding other types of investments. For millennia, gold has served as a store of value, with uses ranging from coinage and jewelry to dentistry and industrial electronics. With a reputation for resilience in the face of adverse macroeconomic trends like rising inflation and political uncertainty, gold has had periods in which it dramatically outperformed other types of investment assets.

There are many different ways to invest in gold, but one of the most popular involves buying shares of exchange-traded funds. ETFs give investors a chance to own small amounts of many different investments within a single fund, letting them get diversified exposure to gold without having to invest huge sums of money. Gold ETFs have attracted their fair share of the trillions of dollars that have gone into ETFs across the market, and their low costs and flexible approaches to investing in the sector make ETFs a useful way to add gold to a portfolio.

Below, we'll give you a list of several of the largest gold ETFs in the market, with detailed descriptions of the approaches they take and their advantages and disadvantages. First, though, let's take a bigger-picture view of how exchange-traded funds became so popular in the first place and how gold investors have used them to take very different approaches toward making money from the yellow metal.

Image source: Getty Images.

How ETFs became a multitrillion-dollar business

To understand how exchange-traded funds got so popular, it's important to understand exactly what they are. ETFs are regulated investment companies that sell shares to investors and then pool together the cash they collect into common pools. Each ETF then takes the pool of money and invests it according to that ETF's particular investment objective. ETFs typically take a passive investment approach, which means that rather than actively making decisions about which investments are more likely to succeed than others, they simply track predetermined indexes that already set out which investments to make and how much money to invest in each. These index ETFs have the goal of matching the returns of the benchmarks they follow, although the costs of ETF operations usually introduce a slight lag below the index's theoretical return.

ETFs have gotten popular for many reasons. The most important is that ETFs let investors get diversification even if they don't have a lot of money. For less than $100 in most cases, investors can buy a single share of an ETF and get exposure to hundreds or even thousands of investments. That keeps investors from having to pick and choose just a small subset of the available investments in a particular area, and that in turn reduces the risk that you'll pick a losing stock and end up suffering a catastrophic loss of capital. ETFs protect their investors from big losses in a single stock, as long as its other holdings avoid the same risks.

ETFs are also popular because there are so many of them, with many different investment objectives. You can find funds for any asset class, including not only stocks and bonds but also commodities, foreign currencies, and many other less commonly followed investments. ETFs also vary in scope, with some drilling down on very small niches of an overall market or industry, while others look to offer the broadest possible swath of investments that meet its investment criteria. It's easy to find an ETF that matches your goals and wishes, because there are thousands of different funds to choose from.

Another big feature of ETFs is that their fees are generally reasonable. All a typical index ETF investment manager has to do is to match the performance of an index, which makes it unnecessary for the fund to do costly research or take other effort to try to enhance return. That makes these ETFs much less costly than traditional mutual funds that employ a more active management approach. Granted, because ETFs trade on stock exchanges, most brokers charge a stock commission to buy and sell shares. But increasingly, the trend has favored no-cost ETF trading, and more brokers are finding ways to encourage ETF investing for their clients.

ETFs have some tax advantages that also make them preferable to traditional mutual funds. The most important is that unlike mutual funds, ETFs almost never have to declare taxable distributions of capital gains that can add to your tax bill. That lets you decide when you want to realize any gains in the value of your ETF shares by selling them.

Lastly, investors can trade ETF shares a lot more freely than they can mutual funds. Whenever the stock market is open for trading, you can buy or sell ETF shares, but with a mutual fund, you can only buy or sell once at the close of the trading day. That gives ETF investors more latitude to respond to changing conditions quickly, rather than forcing you to wait until the end of the day -- when major moves might already have happened.

Why is gold an attractive investment?

Gold's appeal as an investment is rooted in history. Since the days of ancient civilizations, gold has been used in jewelry and coins, in part because of its beauty and in part because of its rarity. As a medium of trade, gold has the favorable monetary attributes of scarcity and compactness, as even small amounts of the yellow metal have enough value to purchase substantial amounts of many other goods. It's hard to counterfeit gold convincingly, as special characteristics like its relative softness and shine aren't shared by many other metals and other materials.

Over time, the supply and demand dynamics of gold have changed dramatically. On the supply side, advances in mining technology have made it easier and cheaper to extract gold from the earth, and that's increased the amount of available gold in the market. However, rising populations have also increased demand for gold for personal uses such as jewelry. Moreover, industrial uses for gold, including fillings for teeth and as a conductive material in high-end electronics, have also emerged and expanded over time. Even though gold coins no longer circulate in everyday transactions, investment demand for gold bullion -- which includes not only coins but also bars of pure gold specifically designed for investment purposes -- also plays a key role in sustaining demand for the yellow metal and keeping prices high. With commodity markets handling purchases and sales involving large quantities of gold, gold prices change on an almost continuous basis as the amount that buyers are willing to pay and sellers are willing to accept fluctuate.

What advantages do gold ETFs have over other gold investments?

Gold ETFs are just one way that investors can put money into the gold market. Alternatives include buying physical gold bullion directly, investing in gold futures contracts that trade on specialized exchanges and give buyers the right to have a certain amount of gold delivered to them for an agreed-upon price at a specific date in the future, or buying shares of companies in the gold business.

Each of these alternatives has pros and cons. Buying gold bullion through a dealer has the advantage of giving you actual physical gold that will track prevailing prices exactly, but the costs involved in buying, selling, and storing physical gold make it less than ideal, especially for those who want to buy and sell on a more frequent basis. Futures contracts offer the advantages and disadvantages of a leveraged investment, letting you control large amounts of gold with relatively little capital. But it's hard to get modestly sized positions in the futures markets, because most futures exchanges set contract sizes for 50 to 100 ounces of gold -- worth about $60,000 to $120,000 at current prices. Individual stocks in the gold industry let you tailor your exposure very precisely, with huge potential rewards if you pick a winning company but equally large risks if you choose poorly.

Gold ETFs have the advantage of letting investors put small amounts of capital to work effectively, and the range of ETFs in the gold space offer several attractive options for those seeking to invest in the yellow metal. Convenient trading and relatively low costs compared to dealers in physical gold also weigh in gold ETFs' favor.

The 2 main types of gold ETFs

Even once you decide that gold ETFs are the best way to invest in the space, you still have another choice to make. Gold ETFs generally fall into two broad categories:

• Some gold ETFs focus on the commodity aspects of gold, seeking to track the price changes of the metal itself. These ETFs typically get exposure to gold either by holding physical bullion themselves or by entering into futures contracts.
• Other gold ETFs invest in the companies that specialize in gold. These include both gold mining stocks, which directly extract the yellow metal from their mining assets; and gold streaming stocks, which provide financing to gold miners in exchange for the rights to purchase a set amount of a mine's gold production at a discounted price.

Within these categories, you'll find plenty of different variations. For instance, some gold mining ETFs concentrate on mining companies that have assets in a particular geographical area. Others focus on different-sized companies, with some holding only the largest mining companies in the world while others seek out up-and-coming small companies with promising prospects.

In general, though, there are things that every gold ETF investor should consider. They include:

• In general, the more assets under management that a gold ETF has, the less expensive it will be to invest in it. Bigger ETFs tend to have lower expense ratios -- the annualized fees that funds charge to pay for their operational expenses -- and the costs associated with buying and selling shares on stock exchanges are also often more modest. Small, illiquid ETFs can be very difficult to trade effectively without incurring much larger trading costs that can eat up any profit you earn.
• Gold mining and streaming company stocks don't always match moves in the price of gold. Sometimes they even move in the opposite direction, especially if a company-specific incident like a mine accident or worker strike affects a miner's ability to produce gold. To invest in gold stocks -- or the ETFs that own them -- you have to be aware of this potential divergence.
• An ETF that holds gold mining stocks can also provide more leverage to a given change in gold prices than a pure commodity gold ETF. The reason has to do with the profits that gold mining companies earn. If gold prices rise from $1,000 to $1,100 per ounce, then an investor in a commodity gold ETF can expect a 10% return. But if a mining stock pays $900 per ounce to produce gold, then the same increase in gold prices doubles its potential profit from $100 per ounce to $200. That can make gold mining stock ETFs much more volatile than their bullion-holding counterparts.

There's no one perfect ETF for every gold investor, but different ETFs will appeal to each investor differently, depending on their preferences on the issues discussed above. The following gold ETFs span the universe of available plays on the gold market, and they each have their own approaches toward helping their investors make money from gold.

4 top gold ETFs

Data source: Fund providers. 

The 2 giants in gold bullion ETFs

The gold ETF industry is dominated by two very similar funds that are focused on owning gold bullion rather than investing in stocks of companies that mine and produce gold.The SPDR Gold Trust began operating in 2004 and has long been the industry leader, holding more than 24 million ounces of gold bullion that provide the basis for valuing the ETF's shares. Originally, each share of SPDR Gold corresponded to roughly one-tenth of an ounce of gold, but over time, the need to pay fund expenses, which total 0.4% per year, has reduced that amount to about 0.0946 ounces of gold per share. There are more than 250 million shares of the SPDR ETF outstanding.

Meanwhile, the iShares Gold Trust is a respectable No. 2 in the space, with holdings of nearly 8.8 million ounces of gold. Its lower expense ratio of 0.25% gives the iShares ETF a cost advantage over its SPDR rival, and its shares are designed to correspond to the value of roughly one-hundredth of an ounce of gold rather than one-tenth of an ounce. Similar erosion in value since its 2005 inception has resulted in each share actually corresponding to about 0.0096 ounces of gold. Although average daily share volume of trading for the iShares fund is higher than for the SPDR, the total dollar volume of those trades is roughly six times higher for the SPDR ETF than for its iShares counterpart.

Both the SPDR and iShares ETFs have done a good job of tracking the price of gold over their histories. The greater liquidity of the SPDR ETF makes it a more attractive choice for frequent traders of the fund, while the lower costs of the iShares ETF give it the advantage for longer-term buy-and-hold gold investors.

2 ways to play gold mining stocks

For gold investors who prefer the exposure that gold mining companies provide over physical gold bullion, two exchange-traded funds from the VanEck Vectors family of ETFs have taken a commanding position over the gold ETF industry. Picking between these two funds depends on your preference of the size of gold mining company in which you prefer to invest.

The larger of these two ETFs, the VanEck Vectors Gold Miners ETF, tracks an index of major global players in the gold mining industry. To qualify for inclusion in the index, a company must get at least half of its total revenue from gold mining or related activities.

You'll find four dozen such stocks in its portfolio, including mining giants Newmont Mining (NYSE:NEM) and Barrick Gold (NYSE:GOLD). Investors in the fund also get exposure to gold streaming companies, with Franco-Nevada (TSX:FNV) representing the ETF's third-largest position as of October 2018. Roughly two-thirds of the fund's assets are invested in stocks of companies located in North America, with most of the remainder split between the resource-rich nations of Australia and South Africa. Even with a substantial allocation to large companies, the average market capitalization of the mining and streaming stocks in the ETF's portfolio is just over $7 billion, showing how many smaller players there are even among the global gold industry's leading companies.

Meanwhile, the VanEck Vectors Junior Gold Miners ETF has a different approach. The index that it tracks seeks to include small-cap companies that are involved primarily in mining for gold and silver. With this investment objective, the junior ETF includes smaller companies that are still in their exploratory or early development phase. That boosts the amount of potential risk, but the rewards of success are that much higher as well.

The VanEck junior ETF currently has 70 different stock holdings, giving it greater diversification than its VanEck counterpart. Even so, many investors are familiar with the fund's top holdings, which include miners like Australia's Northern Star Resources, South Africa's Anglogold Ashanti (NYSE:AU), and Canadian miner Yamana Gold (NYSE:AUY). Overall, the junior ETF has more global balance, with just half of its assets in North America and greater proportions to Australia, South Africa, and parts of the emerging-market world. The average market cap of the stocks in the junior ETF is just $1.7 billion, giving the fund a much different character from the other VanEck fund.

Are gold ETFs right for you?

Finally, it's worth repeating that gold ETFs can be extremely volatile. The three-year returns given above for the VanEck ETFs show just how strong gold mining stocks have been when you look at returns since 2015. But over the past year, losses have been more substantial for the VanEck ETFs than for the commodity gold ETFs, and the same holds true for returns since 2013 as well.

Many investors don't bother adding commodity exposure to their stock portfolios, as the history of market performance has demonstrated that a mix of stocks, bonds, and cash can let you enjoy solid long-term investment returns that you can tailor to your particular risk tolerance and financial goals. However, if the idea of investing in gold has special appeal to you -- or if you like the diversification that an asset with the reputation for safety and security can offer -- then it's worth it to consider whether gold ETFs like the four discussed above can play a role in your overall portfolio. Few investors will put all of their money into gold ETFs, but knowing their characteristics can help you decide how large of an investment is right for you.