Gold ETFs: Deciding What Makes Sense

by Tom Lydon

Gold, gold, gold.

Everyone covets it for one reason or another, millions are out buying it and even more people are talking about it.

Surging interest in the yellow metal is pushing it to new record prices. When prices reach these levels, the result is a bit of navel-gazing in the markets. Why is gold rising like it has been? And, perhaps more importantly, can it continue, or are we gearing up for a spectacular selloff?

A few of the fundamental reasons gold prices are going up and away include:

• International buying. Central banks around the world have been loading up on gold. The International Monetary Fund (IMF) recently sold $403 million to Bangladesh, while China, France and other nations have stocked up.

• Sheer momentum. Gold is expected to gain for the 10th consecutive year as loose monetary policies have flooded the markets with cash.

• Safety. Discussion of quantitative easing from the Fed coupled with lingering concerns about the eurozone still have investors turning to gold for its value as a safe haven.

• Jewelry. It's festival season in India, the world's largest gold consumer. This period in the country drives demand for gold jewelry. Look out, though -- higher gold prices this year could scare some buyers off.

• ETFs. Some observers also believe that the greater interest in gold and silver markets is a direct result of ETFs. The World Gold Council said gold demand grew 414% in the second quarter, and this is largely attributable to ETF demand.

If you're among the investors looking to get a little gold exposure, consider ETFs. Why would you own a gold ETF instead of actual gold? Simply put, it's more convenient.

Owning a gold-focused ETF is a good way to get physical exposure to the metal without the hassle of taking physical possession -- finding storage, paying for storage and so on. Each share of a physically backed gold ETF is just that -- it's backed by 1/10th of a bar of gold.

This gold is stored in secure vaults in London and Switzerland, and the holdings within are audited and inspected on a regular basis. Some investors aren't comfortable with this, and as stated above, if you're not, then gold ETFs may not be the right choice for you.

You have three options to invest in physically backed gold ETFs:

SPDR Gold Shares (NYSE: GLD - News)

iShares COMEX Gold (NYSE: IAU - News)

ETFS Physical Swiss Gold Shares (NYSE: SGOL - News)

The differences between the three come down to both where the gold is held and the expense ratio of each of the funds. After recently slashing its costs, IAU is the cheapest, with a 0.25% expense ratio. GLD and SGOL have a 0.40% and 0.39% expense ratio, respectively. SGOL stores its gold in Swiss vaults, while GLD and IAU have their gold stored in London.

The catch with physical gold ETFs is that long-term capital gains are taxed as collectibles -- a whopping 28%.

If physically backed gold ETFs aren't your style, there are also equity funds that hold miners' stock.

Market Vectors Gold Miners (NYSE: GDX - News) and Market Vectors Junior Gold Miners (NYSE: GDXJ - News) are the two gold miner pure play options available.

The catch with gold miner funds is that they don't track the spot price of gold, so you shouldn't expect them to replicate the metal's performance. Their benefits may outweigh that fact in the current climate.

Both hold the stocks of mining companies. Gold mining corporations held in these funds tend to perform better when the price of gold is elevated, which was demonstrated during the second-quarter earnings season when many of the major players in gold mining reported soaring profits.

However you choose to get your gold exposure, be alert to any signs of a selloff, and have an exit strategy at the ready to avoid getting burned on the downside.


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