Exchange-traded funds (ETFs) give traders access to the incremental price movements of physical gold, without having to buy physical gold or futures contracts. Instead, the ETF does this for the investor.
Gold ETFs are typically structured as a trust. Under this structure, the ETF holds a certain amount of gold for each share of the ETF issued. Buying a share means owning a portion of the gold held by the trust.
The SPDR Gold Trust (GLD) is the most popular gold ETF, with $37 billion in assets under management, averaging more than $797 million a day in volume. According to SPDR, each share is worth 0.095599 gold ounces (net asset value, called NAV). This is why the ETF trades at approximately 1/10 the price of gold. As the price of actual gold fluctuates, so does the price of GLD. Since GLD is publicly traded, investors may push the price above, or below the NAV, meaning that the shares may be worth slightly more or less than 0.95599 gold ounces.
The value of each share (corresponding to 0.095599 gold ounces) is eroded slightly over time, as the ETF charges investors a 0.4% annual fee to cover the managers' compensation. These fees slowly erode the NAV of the ETF, thus slightly reducing the gold ounces each share is worth over time. This is a slow process, however, and 0.4% is a much lower fee than most gold dealers charge for buying physical gold. Therefore, gold ETFs are an efficient vehicle for investing in gold.
Another popular gold ETF is the iShares Gold Trust (IAU), with about $12 billion in assets under management, averaging more than $150 million a day in volume. It has a 0.25% expense ratio, and trades at approximately 1/100 the price of gold. It also holds gold in trust, and has a structure similar to GLD's.
These types of funds, which hold physical gold in confidence, tend to move in line with the price of gold over the short-term and long-term, with only minor tracking errors (when the fund deviates from the price it should be trading at based on the price of gold).
Inverse and Leveraged Funds
There are a number of other gold ETFs, but their volume is significantly less than that of the two mentioned above. There are leveraged and inverse gold funds. The Velocity Shares 3x Long Gold ETN (UGLD) provides exposure to three times the daily movement of gold futures contracts. Its expense ratio is 1.35%, with the average volume at approximately 700,000 shares.
The Gold Double Short ETN (DZZ) trades approximately 500,000 shares a day, has a 0.75% expense ratio, and moves inversely to gold prices. If gold moves up 1% today, DZZ should drop by 2%, because it moves double, and in the opposite direction.
Leveraged and inverse funds are more complex than plain-vanilla gold ETFs, since they don't hold physical gold in trust. ETNs are debt obligations of the underwriter of the ETN. The value of the ETN tracks a commodity index, but is only backed by the credit-worthiness of the underwriter. These complex instruments are intended for short-term trades, since they accurately track just the daily movements in the price of gold, not the long-term changes. Therefore, over time, the leveraged and inverse funds could significantly deviate from where an investor would expect them to trade based on the price of the gold.
The Bottom Line
Gold ETFs operating as trusts are straightforward. The trust holds gold and issues shares. The shareholder has fractional ownership of that gold. The shares reflect the price movement of actual gold, but typically at 1/10 or 1/100 of the metal's price. The amount of gold each share is worth is slowly eroded by the expense ratio, but ETFs are still typically more efficient than buying physical gold and storing it. Inverse and leveraged ETNs are more complex. They track the daily price movement of gold, moving inversely or magnifying the gain/loss, but won't accurately track long-term price changes in gold.