ETF (Exchange Traded Fund)
Exchange Traded Funds track the value of a particular index, commodity (for instance atracks the gold price) or currency and its highly liquid shares can be bought and sold just like stocks on the stock exchange. ETFs may be attractive as speculative vehicles because of their low costs, tax efficiency, and stock-like features.
Eric, Jill and John are in a department store searching for ski equipment. Eric is trying to find a new pair of goggles for himself, while Jill and John cannot decide which gloves they like best.
Exchange Traded Fund (ETF) – an investment fund whose shares are traded on an exchange in a way similar to stocks. The value of the shares of an ETF tracks the value of a particular index, commodity, currency etc. ETFs have gained considerable popularity because of their liquidity, tax efficiency and relatively low costs. Precious metals investors are primarily interested in commodity ETFs that follow the prices of metals. Such ETFs usually allow you to open investment positions that give returns similar to those from actual positions in metals. To open such a position you do not need to buy the underlying metal.
Buying ETF Shares vs. Buying Gold / Silver
One might ask a question: Why buy ETF shares instead of simply buying gold? The answer is simple. It is relatively easy to buy ETF shares even if you are an individual investor. What's more, you do not need to hold physical gold to open a position that behaves similar to a position in gold. This is important as holding physical gold incurs storage costs.
Another advantage of buying ETF shares over buying physical metals is the fact that the shares of ETFs may reflect smaller amounts of gold than contained in typical bars of gold. For instance, if gold is worth $1 500 per troy ounce, it is relatively hard for an individual investor to buy a 1 troy ounce gold bar since he must invest at least $1 500. On the other hand, if a specific ETF follows the price of 0.1 troy ounce, it means that one share of the ETF can be bought for approximately $150 a sum that is more accessible to individual investors. Moreover, there are usually options on ETFs that are rather liquid (bid-ask spreads are relatively small). Consequently, ETFs are a valuable speculative vehicle for traders.
On the other hand, physical possession of your long-term gold & silver investments (not through ETF funds) is preferred. The reason is the possibility that at some point ETF may not track the prices of precious metals to any reasonable extent. This could be caused by turmoil in the financial markets (like we saw in 2008) plus the risk that these funds may not have enough metals to back up their shares
Gold ETF - Risks
Precious metals ETFs usually own considerable amounts of the tracked metal (e.g. gold ETFs usually own - or claim to own - physical gold), however the amount of the owned metal in relation to the total assets of the ETF varies from one fund to another. Typically the more gold an ETF holds (up to 100% of its assets), the less risk is involved. However, one must remember that even an ETF that is fully backed by physical gold involves risk, because holding gold itself involves risk.
ETFs have been criticized for their complicated structure that lacks transparency. This lack of transparency seriously hampers the assessment of the actual risk involved and of possible rates of return. Because of that ETFs have been compared to complicated derivative products.
One example of how such complexity may hinder one’s investment decisions is the reaction of ETFs to changes in price of the underlying metal. If gold gains 10% it does not necessarily mean that gold-based ETFs will gain 10% as well. This is because other factors might have an impact on the complicated structure of the ETF.
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