Has Gold Lost its Luster?

• By Ron DeLegge, Editor
• On 2:14 pm EDT, Thursday September 3, 2009

SAN DIEGO (ETFguide.com) - For most of the year, gold has underperformed U.S. stocks (NYSEArca: VTI - News), international stocks (NYSEArca: EFA - News) and emerging market stocks (NYSEArca: VWO - News). This is a resounding contrast from last year when gold dominated virtually all asset classes. Has gold lost its luster?

So far in 2009, gold as measured by the SPDR Gold Shares (NYSEArca: GLD - News) has gained 11.2%. That's almost triple gold's performance return for all of last year. In 2008, gold rose 4.32% as calculated using Kitco's London PM Fix prices.

In August, Europe's largest bank, HSBC Holdings increased its gold price forecast to $925 from $875 an ounce.

'Concerns that quantitative easing will lead to higher inflation have driven investor demand for gold,' stated James Steel, chief commodities analyst at HSBC.

Most mutual funds only offer gold exposure by investing in gold stocks but not in gold itself. Investing in gold is easily accomplished with gold ETFs. Some products are designed to track the price of physical gold bullion whereas others are tied to gold futures contracts or to the performance of publicly traded stocks that mine and produce gold.

Let's analyze a few key gold ETFs:

SPDR Gold Trust (NYSEArca: GLD - News)

State Street Global Advisors introduced GLD back in 2004 as the first exchange-traded trust linked to the price of gold bullion. The share price reflects 1/10th the price of one ounce of gold bullion. The trust is backed by physical gold, which is stored in the form of London Good Delivery Bars (400 oz.) in a secured vault. GLD has a mammoth $32 billion in assets making it among the largest ETFs in the world.

In 2008, GLD had a modest gain of 2.99% compared to a 37.38% decline in the SPDR S&P 500 ETF (NYSEArca: SPY - News). GLD's annual expenses are 0.40%. 

Market Vectors Gold Miners ETF (NYSEArca: GDX - News)

This Van Eck Global ETF follows the Amex Gold Miners Index. The underlying index contains 32 mining stocks and Barrick Gold , Goldcorp and Newmont Mining represent the three largest holdings. GDX was one of the first gold mining ETFs and it currently has $4.5 billion in assets.

Year-to-date, the gold stocks inside GDX are ahead by 25.38% and are handedly outperforming gold itself. In 2008, GDX fell 26.65% compared to a 4.32% rise the value of gold bullion. GDX's annual expenses are 0.59%. 

ProShares Ultra Gold (NYSEArca: UGL - News)

This ProShares ETF aims to deliver twice (200%) the daily performance, before fees and expenses, of gold bullion as measured by the U.S. Dollar fixing price for delivery in London. This ETF is structured as a partnership and it uses a combination of forward and futures contracts to execute its investment strategy. 

So far this year, UGL has increased in value by 10.66% and its annual expenses are 0.95%.

Stiff Commodity Rules

Before deciding on which gold ETFs to buy, it's important that you be aware of the different strategies. Some products, like GLD take physical delivery of gold and store it in a secured vault. Others gold products get their exposure via futures contracts. Why is this important?

Exchange-traded products that utilize commodity futures contracts are facing a counterproductive regulatory environment that could interrupt their operation. This applies to gold exchange-traded products like PowerShares DB Gold Fund (NYSEArca: DGL - News), PowerShares Precious Metals Fund (NYSEArca: DBP - News), PowerShares DB Gold Double Long ETN (NYSEArca: DGP - News), PowerShares DB Gold Double Short ETN (NYSEArca: DZZ - News), ProShares UltraShort Gold (NYSEArca: GLL - News) and the ProShares Ultra Gold (NYSEArca: UGL - News). Instead of investing in physical gold, each of these gold ETFs and gold ETNs utilizes futures contracts to obtain their gold exposure.

Even though it has yet to produce any credible evidence, the U.S. Commodity Futures Trading Commission (CFTC) claims that commodity index funds and other investors that take large positions in futures contracts tied to various commodities are needlessly distorting the financial markets.

Unknown Impact

As a result of the CFTC's bold stance, commodity exchange- traded products are encountering difficulties amid an increasingly restrictive regulatory environment impacting investments that use commodity futures. Last week, Barclays Global Investors (BGI) temporarily suspended the creation of new shares for its iShares S&P GSCI Commodity-Indexed Trust (NYSEArca: GSG - News). Other products like the PowerShares DB Crude Oil Double Long Exchange Traded Notes (NYSEArca: DXO - News) are being liquidated. All of these products have the same thing in common: They use commodity futures contracts to get their market exposure.

While the CFTC's restrictions have not yet caused any specific gold ETFs or gold ETNs to announce changes in the way they're managed, the turmoil with broadly diversified commodity funds like GSG along with other commodity focused products is a warning sign that trouble could be ahead. 

Gold in Your Portfolio

Beware of the financial extremists that tell you the only way to benefit from rising gold prices is by investing in physical coins, bars, or jewelry. It's not true.

Gold ETFs allow you to have an ownership stake tied to physical gold, gold futures, or gold equities. In many cases, the cost of acquiring gold exposure through gold ETFs is substantially less than taking physical delivery of gold. Also, the acquisition costs may be less with gold ETFs than with middlemen peddling physical gold. Do the math! Keep in mind that gold ETFs allow you to avoid the expense and inconvenience of storage and insurance.

Conclusion

In summary, beware of gold ETFs and gold ETNs that use commodity futures contracts. Trouble could be brewing on the regulatory front.

A recent analysis of gold prices relative to the price of stocks, treasuries and the U.S. dollar provided solid guidance on where the future direction of gold could be heading. 

And lastly, don't overdose on your gold exposure. People that made the strategic mistake of investing all of their money in gold at its peak in 1980 sat on dead money for more than two decades. Don't make the same blunder!

In the context of a diversified portfolio, gold can be successfully used. It may stabilize your ETF portfolio during unstable times. It may even help you to reach your financial goals.

Buzz up!