Should investors look at gold mining ETFs over gold ETPs?

Jul 28th, 2016 | By | Category: Commodities

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Gold is making a comeback this year as investors look for safe-haven assets amid volatile markets, falling high grade bond yields and political events such as the EU Referendum. Data from exchange-traded product provider WisdomTree last week showed that gold ETPs have seen inflows of around $21bn in the first six months of the year. The metal is also trading at around $1,319 an ounce, which is up 24% since the beginning of the year.

Danny Dolan, Managing Director of China Post Global (UK)

Danny Dolan, Managing Director of China Post Global (UK)

However, there is a strong possibility that gold is now over-priced, leaving little room for investors to buy the yellow metal at a sensible level. Instead, one market commentator suggests looking to gold mining exchange-traded funds.

Rebecca Hampson, Associate Editor at ETF Strategy talks to Danny Dolan, CEO China Post Global (UK) about why investors should look at gold mining ETFs.

RH:  Why would an investor choose a gold mining ETF over a physical gold ETP?

DD: Investors use gold mining ETFs as an alternative to physical gold and gold-backed securities.

Physical gold and gold-backed securities cannot be offered in a UCITS format, and exchange-traded notes (ETNs) and exchange-traded commodities (ETCs) don’t have the same attributes as UCITS ETFs in terms of investor protection, risk monitoring and transparency. A gold mining index can be offered as a UCITS ETF.

Gold mining stocks and gold are also highly correlated. Particularly stocks of gold mining companies that don’t hedge their gold production (by selling some of their future production at current gold prices) offer very good exposure to the spot price of gold.

Some investors choose gold mining equities over physical gold because an increase in gold prices yields a higher increase in gold mining companies’ profits (assuming extraction costs remain the same). However, when gold prices decline, gold mining companies’ losses are magnified.

RH: Physical gold is a safe haven asset, how does this fit with gold mining stocks (equities)?

DD: Gold mining stocks are influenced by company and industry fundamentals – having said that, the gold mining industry is currently in very good shape. Some of the largest companies in the sector have cut costs in recent years and improved their liquidity, credit profile and efficiency of production. They have also benefited, and continue to benefit, from low oil prices. In addition, they benefit from low financing costs due to the current low interest rate environment.

Investors who consider gold a “safe haven”, or wish to benefit from a higher gold price use gold mining equities as an alternative to physical gold and gold-backed securities. Selecting a UCITS ETF that tracks an index of gold mining equities reduces company-specific risks.

[Note: Investors looking to add commodities to their portfolio for diversification purposes wouldn’t be able to meet their investment objective by only adding gold to their portfolio. They would need to invest in a broad commodities index or a diversified basket of commodities.]

RH: How does this type of ETF get impacted by the actual price of gold? (When the gold price rises in times of stress is there much point in buying it?)

DD: Our ETF is strongly correlated to the spot price of gold, as the index only includes companies that don’t hedge their gold production beyond 1.5 years.

Ever since its launch in 2007, it has remained strongly correlated to the gold spot price throughout all stages of the market cycle.

RH: There are some views that gold is not as useful as a safe haven as is made out. Why are gold mining stocks any better?

DD: Gold has an enduring attraction as a “safe haven” asset due to its ability to hold its value throughout turbulent periods. Investors turn to gold in times of uncertainty, and strong demand pushes gold prices up. This benefits the gold mining industry strongly.

The price of gold has increased dramatically in recent months and could increase further which creates opportunities for gold mining companies.

RH: Should investors continue to look at gold and gold-related products?

DD: Gold and gold mining equities remain an attractive investment. Demand for gold is expected to remain strong as uncertainty is likely to be prolonged. Demand for gold could in fact increase and push gold prices further up, as a result of heightened uncertainty, macroeconomic and geopolitical risks.

There is a clear opportunity for gold mining companies as production costs are low, demand for gold is strong and the gold price is likely to continue its upward trend as a result of uncertainty and low interest rates.

Gold mining ETFs have performed well YTD.

Gold mining ETFs have performed well YTD.

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