A Gold Bug's ETF Plays

By Tim Parker | November 01, 2010 AAA

Have you noticed that gold is always in the news? Gold has been at the forefront of the investment markets for hundreds of years. Some historians believe that investment in gold started as early as 628 AD, and it has gone from being the accepted currency in many countries to being the commodity that all other metals are judged against. (To learn more, see 8 Reasons To Own Gold.)

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How Do You Play It?

As popular and widespread as gold is, there are only a few ways for investors to trade the precious metal. The first way is to own the physical product. The price of gold has gone up so rapidly that vending machines now exist where people can buy small amounts of gold at the daily commodity price. But short of that, gold bullion is the only other physical way besides investing in jewelry or other products containing gold.

Another popular way to invest is by way of exchange-traded funds (ETFs). We've picked three of the most popular gold ETFs to look at. Each of these ETFs provides a different way to invest in gold.

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SPDR Gold Shares GLD

For the investor who wants to directly play the performance of gold bullion, SPDR Gold Trust (NYSE: GLD) is the ETF of choice. Some commodity ETFs are criticized because their large size produces high volumes of trades, which can cause false movements in the underlying commodity. GLD owns a large amount of gold bullion, in part to prevent this from happening.

One word of caution when investing in any of these ETFs: Like any ETF, there are management fees built into the price that can degrade profits. There is also something called rebalancing. We won't explore the act of rebalancing in this article, but if gold rises 1% in value in six months and you notice that GLD does not, the reason for that is most likely management fees and rebalancing.

For those reasons, some market pundits do not believe these ETFs make efficient long-term investments. In their view, the longer these funds are held, the more money is lost due to rebalancing. Their advice is to invest in physical gold when you believe gold will rise in value.

ProShares UltraShort Gold ETF GLL

For investors who have held the ProShares UltraShort Gold ETF (NYSE: GLL) in 2010, we're sorry. Gold has been on a constant and dramatic trend higher in 2010. For that reason, investors who held a short position in a gold ETF lost a lot of money. In fact, GLL is down close to 40% for the year.

The GLL is a leveraged ETF. This means that this fund moves twice the amount in the opposite direction of gold. That's a lot of big words to say that when gold loses value, you make money. Assume that the price of gold drops 1.5% on a given day. GLL will move twice as much in the opposite direction; so when gold drops 1.5%, GLL will rise 3% (before fees). Don't forget that management and rebalancing fees are built into the price. As a result, the movement will be slightly less than 3%.

When to Invest: When you believe that gold will lose value. Leveraged ETFs - those that move twice (or even three times) as much as the underlying asset - are largely used by day traders to catch short-term movements in a stock. It is not advised to use this fund as a long or even medium-term investment vehicle.

Market Vectors Gold Miners ETF GDX

What if you don't want to invest in the actual movement of gold bullion? Another way to make money in the gold market is by investing in companies that mine, process or sell gold - like the Market Vectors Gold Miners ETF (NYSE: GDX). How is this a different kind of investment? When you invest using GLD or GLL, you're tracking the price of gold, the commodity. When you invest in gold companies, you're investing in a company's ability to make money. You must have confidence in the company's management, balance sheet, earnings potential and everything else you evaluate when investing in a company.

Invest when you don't want to invest in the commodity and believe that gold, and the companies who work with it, will gain value.

Should I Invest In The Commodity Or The Company?

Because the market changes every day, we can't tell you which is the better investment. But there's an easy way to answer that question for yourself. Go to your brokerage website and generate a chart for GLD. All brokerage sites should allow you to place multiple stocks or ETFs on the same chart, so add GDX to your GLD chart. Is one clearly outperforming the other?

The Bottom Line

You can find gold in the portfolios of most professional investors. If it's good enough for them, it's good enough for all of us - but be careful. Gold has been on a dramatic upward rise in 2010. "Buying high" can be dangerous. (To learn more, check out Getting Into The Gold Market or discuss commodities trading at TradersLaboratory.com.)

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