InvestmentsFeb 20 2018

Gold: understanding the difference between price and value

  • To understand how gold is valued by investors.
  • To list different ways in which investors can access gold.
  • To learn about the risks involved with certain ways of accesisng gold.
  • To understand how gold is valued by investors.
  • To list different ways in which investors can access gold.
  • To learn about the risks involved with certain ways of accesisng gold.
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Approx.30min
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Gold: understanding the difference between price and value

As investors purchase new units, the ETC provider compliments the net trade (after the sellers have been accounted for) by buying then storing new gold bars in its vault. At any time the holders of the ETC will have full direct exposure to the physical gold.

As a result the share price for the physical ETC closely tracks the spot gold price. The fees of 0.4 per cent to 0.6 per cent are based on the cost of storage.

Investors who want instant exposure to gold as they believe the price will rise may decide to use a synthetic ETC. Unlike the physical ETC, the units in the synthetic ETC are not physically backed with the metal.

Instead the ETC uses derivatives to track the gold price or a variant of it. The simplest synthetic ETC is one which uses swaps. Here investors via the ETC post collateral, in the form of cash, and in return they have an arrangement with a counterparty who, for various reasons, wants to take a short position in gold.

As the gold price rises above the reference rate the investors in the long synthetic gold ETC will make money at the expense of the counterparty who will be required to pay margin.

One benefit of these synthetic swap ETCs is that whilst the ETC is not backed with physical gold there is collateral backing the investment, in the form of cash. However the counterparty is often a financial organisation, which many Armageddon investors distrust.

Using derivatives, investors can become speculators. If someone believes that gold is going to increase in price then there is the ability to purchase a leveraged long gold ETC.

Here 3x leverage can be used. Conversely if someone is pessimistic on the outlook for gold then they can purchase a short 3x leverage gold ETC. By using derivatives long-term investors suffer from negative roll yield if the gold price is in contango, when the future gold price is higher than the current gold spot price.

This is because more expensive future contracts are purchased to replace the maturing existing contracts whose price has converged to spot.

The cost of using future contracts can be seen in the chart below. While the price of the physical gold ETC has risen 23 per cent since November 2015, the price of the synthetic gold ETC has risen 19 per cent. The 2x and 3x leveraged gold ETCs have risen 35 per cent and 50 per cent respectively.

Source: Morningstar     

2) Indirect exposure

If one wants investment exposure to gold, there is the option of investing in companies which produce the gold.

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