Gold, often seen as a haven for investors, holds a special place in the investment world. Its value extends beyond just being a hedge against inflation; gold is also prized for its ability to diversify a portfolio.
This attribute largely stems from its low correlation with both stocks and bonds and its reputation as a "flight to safety" asset during economic turmoil. When markets are in disarray, gold often becomes a favored destination for investors seeking stability.
However, gaining exposure to gold can present its own set of challenges. Physical gold ownership involves ongoing storage and insurance costs, which can be cumbersome and expensive. Additionally, there are often significant spreads involved when buying and selling.
On the other hand, gold futures offer an alternative route but come with the complexities and risks inherent in derivatives trading. Moreover, futures may not always accurately track the spot price of gold, leading to potential discrepancies in performance.
For Canadian investors seeking a more straightforward way to invest in gold, gold ETFs offer a liquid, affordable, and accessible means to gain gold exposure through a standard brokerage account. Here's all you need to know before buying a gold ETF in 2023.
Watch out for Gold CEFs and ETRs!
Firstly, it’s important to clarify some distinctions within the realm of gold investment products, particularly regarding Closed-End Funds (CEFs) like the Sprott Physical Gold Trust (NYSE:PHYS) (PHYS) and Exchange-Traded Receipts (ETRs) like the Royal Canadian Mint Canadian Gold Reserves (TSX:MNT) (MNT).
These instruments, while similar to ETFs in some respects, differ significantly in their structure and how they operate.
CEFs like PHYS are structured differently from typical ETFs. Once a CEF issues a set number of shares through an initial public offering (IPO), it does not issue new shares or redeem existing ones in response to demand in the market. Consequently, CEFs trade on an exchange just like a stock, and their price is determined by market supply and demand, which may lead to prices that deviate significantly from the fund's Net Asset Value (NAV).
On the other hand, ETRs like MNT also represent a direct investment in physical gold, where each receipt generally corresponds to a specific quantity of gold. These receipts can be bought and sold on an exchange, but similar to CEFs, they do not have a creation/redemption mechanism. As a result, ETRs can also trade at a premium or discount to their underlying NAV, depending on market conditions.
The lack of a creation/redemption mechanism in both CEFs and ETRs is a critical point of difference from ETFs. This mechanism in ETFs allows for the continuous creation of new shares or redemption of existing ones, which helps ETFs maintain a price close to their NAV even during times of high demand or limited supply.
In contrast, CEFs and ETRs can experience significant price variations from their NAV during periods of intense buying or selling pressure. For investors, this means that while CEFs and ETRs can offer opportunities (such as purchasing at a discount or selling at a premium), but they also carry the risk of price deviations from the actual gold value they represent.
Hedged or Unhedged Gold ETFs?
When considering gold ETFs, a crucial factor to weigh is whether to opt for a currency-hedged or unhedged version. This decision hinges on how currency fluctuations can impact your investment.
Gold is typically priced in U.S. dollars (USD), but these ETFs are traded in Canadian dollars (CAD). As a result, any changes in the exchange rate between the USD and CAD can add an extra layer of volatility to your investment.
In an unhedged gold ETF, currency fluctuations directly affect the fund's value. If the USD strengthens against the CAD, the value of an unhedged gold ETF will likely increase for Canadian investors, and vice versa. Therefore, a rising USD generally benefits an unhedged ETF, while a strengthening CAD can negatively impact it.
To counter this currency-related volatility, some gold ETFs employ currency hedging using derivatives. This strategy aims to neutralize the impact of currency movements, making the ETF's performance more closely tied to the actual changes in gold prices rather than currency fluctuations.
However, it's important to note that currency hedging involves additional costs. These costs can drag on the ETF's returns over time, especially if the hedging strategy doesn’t perfectly align with currency movements.
Deciding between a hedged or unhedged gold ETF depends on your individual investment goals, time horizon, and risk tolerance. If you're looking to purely focus on gold's price movements without the added complexity of currency risk, a hedged ETF might be more suitable.
However, if you're willing to accept currency fluctuations as part of your investment in gold, or you have a view on the future direction of the USD/CAD exchange rate, an unhedged ETF could be more appropriate.
The Current Available Canadian Gold ETFs
Once these concepts are mastered, prospective Canadian gold investors can easily find a list of available gold ETFs via the Cboe Canada ETF Screener. Some examples include the:
- Purpose Gold Bullion Fund (TSX:KILO) (KILO) and its unhedged version KILO.B.
- CI Gold Bullion Fund (TSX:VALT) (VALT) and its unhedged version VALT.B.
- iShares Gold Bullion (TSX:CGL)(CGL) and its unhedged version CGL.B.
The above-noted three ETFs all hold physical gold bullion as their underlying in secure, audited vaults. For synthetic exposure via gold futures, investors can also consider the Horizons Gold ETF (NYSE:GLD) (HUG) as an alternative.
Finally, advanced investors can access strategies like covered calls, leveraged, and inverse exposure when it comes to their gold via ETFs like the Horizons Gold Yield ETF (HGY), the Horizons BetaPro Gold Bullion 2x Daily Bull ETF (HBU), and the Horizons BetaPro Gold Bullion -2x Daily Bear ETF (HBD).
This content was originally published by our partners at the Canadian ETF Marketplace.