Among many effects that 2020 has had on global markets, one is that gold has been reaffirmed globally as a strategic asset amidst a high-risk and low-rate environment, in turn spurring investment demand and the expansion of the gold-backed ETF market.
The increased quantity, size, and location of gold-backed ETFs have provided easier and more efficient access for investors allowing them to utilize many general advantages of ETFs.
While there are numerous ways for investors to own gold, such as bars, coins, derivatives, OTC instruments and gold stocks, many have embraced gold-backed ETFs for qualities such as cost efficiency, transparency, and liquidity.
The growth and evolution of gold-backed ETFs have already helped advance the broader gold market and are likely to continue to do so, providing additional support for the role of gold in portfolios.
Gold ETFs are global
Through September 2020, holdings in the 83 active gold ETFs tracked by the World Gold Council totaled 3,880 tons (t), with total AUM of $235.4 billion (bn) – record highs in both tonnage and value terms.
One of the reasons for this growth is geographic diversification of gold investors compared to 17 years ago, when access to gold via ETFs was limited to a few funds, primarily in North America. While gold ETFs listed in North America continue to expand, maintaining their relevance on a global scale, funds in other regions of the world have also seen remarkable growth since their introduction. In particular, European funds saw a rapid growth in their share of global gold-ETF assets: 41% in September 2020 vs 16% 15 years ago. Meanwhile, total gold holdings in Asian gold ETFs grew from 1t in March 2007 – when the first Asian fund was introduced – to 121t in September 2020, adding seven new funds in 2020 alone.
Total cost of ownership plays a key role in gold investment choices
Investors can gain access to the underlying performance of gold in a handful of ways. Many investors prefer to hold gold in the form of bars and coins, while others actively trade gold futures and gold-relevant stocks, like gold miners. Considerations like portfolio sizing, rebalancing frequency, operational aspects, leverage, commissions, bid/ask spreads, storage and insurance costs and holding periods are just a few of the explicit and implicit costs an investor might use to formalize the total cost of ownership and ultimately their investment choice.
Although gold futures, vaulted gold, mining stocks, and bars and coins remain very relevant and important investment tools, gold ETFs have attracted investors for several reasons. These include:
- Cost efficiency: While expense ratios of major global mutual funds with precious metal strategies range from 98 basis points (bps) to 456bps1, global gold-ETF management fees vary between 7bps and 297bps per year due to the economies of scale afforded by their structure2. Many investors have shifted gold exposure to low-cost gold ETFs, using various funds listed in the US and Europe, many of which charge less than 20bps a year. This trend in gold ETFs is a by-product of the broader ETF market.
- Transparency: Gold ETFs hold gold bullion in a standardized form of quality, measured in troy ounces, kilograms, or grams. For instance, many gold ETFs around the globe exclusively hold London Good Delivery bars, each weighing approximately 400 troy ounces with a minimum fineness of 99.5%, based on the LBMA gold price. More recently, many funds, particularly in Asia, have linked their gold ETFs to newer benchmarks like the domestic price of gold in India3 and the Shanghai Gold Benchmark contracts in China. This has allowed local investors to have direct exposure to local gold pricing within their respective regions.
- Liquidity: Collectively, global gold ETFs’ trading volumes averaged US$1.8bn per day in 2019 and have nearly doubled to US$3.5 billion per day so far in 2020 rivaling most stocks globally. Such a deep and liquid market enables retail investors to trade gold ETFs with minimal friction costs and is also capable of facilitating large trades for institutional investors. A deep and broad market has provided investors with an extra source of liquidity in times of distress, like the financial market sell-off witnessed in March 2020.
How to Understand Gold Performance
While investors are clearly embracing gold as evidenced by strong demand (particularly for gold-backed ETFs), understanding how to value gold remains a barrier for some. Qaurum is a web-based quantitative tool that helps investors intuitively understand the drivers of gold performance. Behind its user-friendly interface, Qaurum is powered by the Gold Valuation Framework (GVF), an academically validated methodology based on the principle that the price of gold and its performance can be explained by the intersection of demand and supply.
Accessible from Goldhub.com, the World Gold Council’s data and research site, Qaurum allows investors to assess how gold might react across different environments in three easy steps:
- Select a hypothetical macroeconomic scenario provided by Oxford Economics, or customize your own.
- Generate forecasts of demand and supply, and view the impact of key macro drivers.
- Calculate and visualize implied returns for gold.
Based on these, investors can use Qaurum to calculate hypothetical performance of gold over the next five years, as well as 30-year returns implied by GVF and the available or user-constructed scenarios.
Learn more about Qaurum and the GFV methodology.
Positive structural changes and increased availability
Structural changes have played a role in the evolution of the global gold ETF landscape. The establishment of the Shanghai Gold Exchange (SGE) created a fundamental opportunity for gold investment in China. When China lifted its ban on retail bullion trading in 2004, the nation’s annual gold investment demand surged by 59 times between 2003 and 2013, partially contributing to the birth and expansion of the region’s gold ETF market. 4
Regulatory support in local markets for the listing of gold-backed ETFs has been an important driver of the rising geographic diversity in the gold-backed ETF market. Currently, there are funds listed in 18 countries,5 enabling the introduction of currency-hedged gold-backed ETFs, which allow an investor to hold gold in a non-local currency of their choice.
Competition reduced premiums and benefitted retail investors
The emergence of gold-backed ETFs has positively impacted the retail physical gold market. As the popularity of gold-backed ETFs has grown, their cost-effectiveness has triggered additional competition in the retail market. While data for premiums on bars and coins is not always accessible, available data combined with anecdotal evidence suggests that as the gold-backed ETF market has grown and developed, retail physical gold investment products in developed markets have experienced lower price premiums.6
1 Based on data from 253 mutual funds with a precious metals strategy as of 30 September 2020 sourced from Bloomberg.
2 Based on physical gold-backed ETFs we track as of September 2020.
3 Domestic price of gold in India is the landed cost of gold, which can include inputs like taxes and duties, transportation, and manufacturing costs, etc. The local MCX gold Index includes the landed cost plus the premium or discount in the market and can be considered a close proxy to the domestic price of gold.
4 Investment demand is calculated as the sum of demand for gold bars and coins and ETF inflows (which were not available until 2013) in China.
5 As of 30 September 2020.
6 Regions that have a few small or even no gold ETFs have not experienced the same premium reductions. However, it is possible that newer gold ETF markets like China and India could experience this effect as additional products create a more competitive landscape.