Physical Gold vs. Gold Funds: Which is More Efficient? (2024)

Gold ETFs

Gold exchange-traded funds (ETFs) give traders exposure to the price movements of gold without having to buy the physical underlying asset. Gold ETFs are typically structured as trusts. Under this structure, the ETF holds a certain number of gold bars for each share of the ETF issued. Buying a share of the ETF means owning a portion of the gold held by the trust.

Because these ETFs hold physical gold, their prices move with the price of gold over the short and long term. However, there are sometimes minor tracking errors when the ETF price deviates from its reference asset. When tracking errors occur, arbitrageurs quickly step in.

There are many gold ETFs. We will consider two of the most popular choices.

SPDR Gold Shares (GLD)

The SPDR Gold Shares ETF (GLD) is one of the largest gold ETFs. As of August 2023, the fund held roughly 29 million ounces at vaults in London and other locations, for a net asset value (NAV) of over $56 billion. Each share of the ETF is worth 0.06052 ounces of gold.

As the price of actual gold moves, so does the price of GLD. Investors may push the price above or below NAV, meaning individual shares may be worth slightly more or less than their equivalent 0.06052 ounces of gold.

At the fund's inception shares were worth one-tenth the price of gold. However, the amount of gold represented by each share is slightly eroded over time as the ETF charges investors a 0.4% annual fee. These fees slowly lower the NAV of the ETF, thus slightly reducing the amount of gold that a share is worth each year. This fee is relatively modest in the context of gold's long-term gains. According to Statista data, gold returned an average of 7.78% per year since 1971. Physical gold storage and insurance fees for small investors are usually higher than 0.4% per year. Therefore, gold ETFs are an efficient vehicle for investing in gold.

iShares Gold Trust (IAU)

Another popular choice for gold investors is the iShares Gold Trust (IAU) from BlackRock. As of August 2023, the ETF held over 14.152 million ounces for a NAV of $27.3 billion. Based on 747 million shares outstanding, each share represents about 0.0189492 ounces of gold. This will erode over time, as the fund has an expense ratio of 0.25%. Like SPDR Gold Shares, the iShares Gold Trust is organized as a trust, holding physical gold bars at vaults in London and New York.

Leveraged and Inverse Gold ETNs

Leveraged and inverse gold funds are also available. These funds are more complex than vanilla gold ETFs because they do not physically hold the asset in trust. Instead, leveraged and inverse funds often trade as exchange-traded notes (ETNs), which are debt obligations of the ETN's underwriter. The price of the ETN tracks a commodity index. However, an ETN depends on the creditworthiness of the underwriter and does not give investors ownership of gold.

Leveraged and inverse gold ETNs are intended only for short-term trades. They attempt to track gold's daily movements, not the long-term changes. The use of leverage over time can magnify losses from volatility. Inverse gold funds have negative expected returns in the long run because the price of gold generally rises in a fiat money system.

VelocityShares 3x Long Gold ETN (UGLD)

The VelocityShares 3x Long Gold ETN (UGLD) aims to provide three times the return of the S&P GSCI Gold Index ER for a single day. This means the shares are meant to be held only for the short term. The ETN is issued by Credit Suisse and has an expense ratio of 1.35%.

DB Gold Double Short ETN (DZZ)

The DB Gold Double Short ETN (DZZ) moves inversely to gold prices. If gold moves up 1% on the day, DZZ should drop by 2% because it moves twice as much in the opposite direction. The notes are thinly traded and the expense ratio is 0.75%. Deutsche Bank launched the ETN in 2008, however, in 2016 it announced it would suspend further issuances.

The Bottom Line

Gold ETFs operating as trusts are straightforward. The trust holds physical gold and issues shares. The shareholder has fractional ownership of that gold. The shares reflect the price movement of actual gold, typically at about 1/10th or 1/100th of the metal's price. The expense ratio slowly erodes the amount of gold that each share represents. However, ETFs can be more cost effective than buying physical gold and storing it. Inverse and leveraged ETNs are more complex than ETFs. They track daily gold price changes by going in the opposite direction or magnifying price movements. Leveraged and inverse ETNs do not accurately track long-term gold price changes.