Alternatives to Gold Mutual Funds: Gold ETF (Exchange Traded Funds)

Some interesting things are happening in the ETF world right now that will greatly increase investors options for investing in gold and gold stocks, and might ultimately make them a better choice than gold mutual funds depending on your investment need.

ETF’s are Exchange Traded Funds and they are essentially mutual funds that are traded on a stock exchange in the same way that regular stocks are. So, purchasing a share of an ETF means that you are buying into a grouping of multiple stocks that either (1) track an index (i.e. S&P 500), or (2) have been bundled as part of a specific strategy (i.e. small cap China, India and Brazil growth stocks, etc.). This can be good if you want a broader exposure to an industry or an index than the purchase a single gold stock allows. It also means that you can do certain things with ETF’s that can’t do with mutual funds, like selling short or buying options.

That’s a very, very basic description of ETF’s. If you aren’t an experienced ETF investor, then you should read this to get a more in depth explanation of what they are and do other additional research on your own before jumping in.

Now that we have a basic understanding of what ETF’s are, lets talk about how you can use them to get exposure to gold. If you’re looking to invest in gold stocks, you really have 3 options:

  1. Buy gold mining stocks
  2. Buy gold mutual funds
  3. Buy gold ETF’s

Options 2 and 3 are similar, but there are important developments happening right now that will give gold ETF investors greater flexibility than gold mutual fund investors. Before we get into those new developments, let’s talk about some differences between gold ETF’s and mutual funds.

Some gold ETF’s are more targeted to the gold industry specifically and are actually designed to track the gold pricing index. In general, mutual funds are a little more broad and may include a grouping of a number of different commodities rather than one specific commodity like gold: i.e. Vanguard Precious Metals and Mining (VGPMX), which tracks a number of different precious metals including gold.
In contrast, there are popular gold ETF’s available (streetTRACKS Gold Shares (GLD), iShares COMEX Gold Trust (IAU)) that are designed to increase or decrease in price in lock step with the price of gold in much the same way that an investment in actual gold bullion or coins would. So if you want that direct exposure to the price of gold in your investment portfolio, but would rather gain that exposure through your investment account than by purchasing gold jewelry, bullion or coins, this is a good solution.

Every investment option we’ve talked about thus far is for investors who believe that the price of gold will go up and want exposure to gold or gold stocks in order to profit from that rise in price. But what if you think that gold’s legendary run over the past few years is over and the price of gold is going to go down? Is there anything that investors can do to both (1) hedge against a drop in the price of gold, to protect gold investments in your portfolio, or (2) profit from a decrease in the price of gold? The answer is yes you can and it’s about to get a whole lot easier to do so with some new ETF developments that will be occurring soon.

Previously, the only option for an investor who wanted to profit from a decrease in the price of gold was to engage in a short sale of a gold stock or gold ETF. But short selling is slightly more complicated than the regular buying and selling of stocks, and requires an investor to open a margin account.

Enter ProShares, a company specializing in inverse ETF’s. ProShares inverse or “short” ETF’s increase in value when the sector they follow loses value, usually in direct or close to direct proportion. This allows investors to get the same effect of a short sale of an ETF (i.e. profiting from a decrease in sector or index value) through a normal purchase in their investment account.

ProShares has the following ETF’s awaiting approval by the SEC:

ProShares Short Gold
ProShares UltraShort Gold

Generally, ProShares UltraShort ETF’s increase in value 2 times for every 1 time the index they track decreases in value, whereas ProShares Short is usually designed to be on a 1 to 1 basis. Neither of these ETFs are available now, but you can check the status on the ProShares website.

ETF’s are another way for investors to gain exposure to gold and gold stocks. Short ETF’s allow investors to gain inverse exposure and profit on gold’s decline. None of these investment options should be taken lightly as commodities in general are very volatile and most investors will never have a need for the short positions that ProShares Short and UltraShort ETF’s offer. So do some serious research if you’re thinking about making gold and gold ETF’s a part of your portfolio. The Motley Fool and Morningstar are great resources. If, after doing so, you are still on board with gold ETFs, make sure to keep you portfolio diverse and don’t over commit to a single investment idea.