10 Years On

Launching with less than A$5 million in assets (supported by Tuckwell himself), GOLD was a mere drop in the ocean but one that has helped to create an industry with at least 54 physically backed gold ETPs with around 81 million oz, worth $130 billion, in assets and daily trading volumes of over $2 billion, including one of the world’s largest ETFs, the GLD.

The gold ETP – gold investment made simple

Before the gold ETP came along, there were a number of ways to invest in gold, which included buying direct bullion, gold certificates, gold coins, gold savings plans and purchasing shares of gold mining companies. Each of these ways to gain exposure to gold came with its own advantages and disadvantages; however, there was no way of owning physical gold simply and cost-effectively. The gold ETP combined the advantages of Exchange Traded Funds (which were first created more than 10 years before GOLD) and that of owning physical gold bullion:

• Exchange traded: easy to buy and sell as little as one share (approximately 0.10oz), in an ordinary brokerage account
• Simple and convenient: can be traded in small or large amounts, and without the need to open special accounts or sign special documentation
• Open-ended: creation and redemption through delivery or receipt of physical gold bars means that gold ETPs will track gold bullion prices
• Allocated bullion: backed by globally accepted London Good Delivery bars, allocated bullion is free of credit risk
• Cost-effective: charges of around 0.40% p.a. with no entry or exit fees (other than equity brokerage charges)
• Tracks the gold price: a gold ETP is 100% correlated with the gold price
• Robust, secure and transparent: most gold ETPs have excellent websites and information, including gold bullion bar lists
• Eligible: certain types of investors, including many types of funds, are not allowed to own physical commodities. These rules probably stem from when gold bullion was less mainstream and thought to be relatively ‘illiquid’ since it was not listed. With the advent of a fund or security backed by gold, restricted investors were able to purchase gold ETPs, thus physical gold could be indirectly be held by investors previously barred from such investment. This opened up gold investing to the masses.

Now that the gold ETP exists, the idea and product seem so simple. However, its simplicity is contained in its complexity. The gold ETP often brought equity trading and commodity trading together like never before. These departments at large investment banks are well separated, and often located in different offices and even countries. Their standard contracts use different terminology (e.g. ounces versus shares); they are often regulated by different entities, e.g. the Commodity Futures Trading Commission (CFTC) versus the Securities and Exchange Commission (SEC); and the staff of these very different departments often didn’t know the other existed, or at least they had never met before.

Why invest in gold – the growth of alternative assets

A number of events occurred to make the gold ETP possible, which in turn made gold investing simple and easy. However, many investments are simple and easy to access yet don’t last long enough to turn a profit before they are shut down. But luckily for the gold ETP, the perfect storm was brewing! People invest in gold for many different reasons and gold behaves differently at different times. Many of the reasons as to why one would invest in gold have really come to the fore since the turn of this century.

Gold is uncorrelated to the major asset classes. However, during times of stress (e.g. when equities have fallen by more than a certain threshold, e.g. 2%), gold tends to outperform other assets and be negatively correlated, making gold a useful tail risk or event hedge, especially when trust is low and/or credit risk appears to be high.

With equities having performed poorly over the past 11 or so years and having become more highly correlated with each other due to the globalisation of financial markets, alternative assets came to the fore as investors sought out alternative assets that would help to diversify their portfolios and reduce downside risk. Hedge funds, gold and commodities suddenly became popular.

Fundamentals have also played an important part. On the supply side, central banks started to limit gold sales and then became net buyers; gold-mining companies stopped selling forward their production at low prices ($250 to $300/ oz back in the late 1990s and early 2000s); and production in the main gold-producing regions (US, South Africa, Australia and Canada) began to slide and production costs started to rise. On the demand side, gold started to play a part in portfolios, the gold ETP started to add to demand, low interest rates lowered the opportunity cost of holding gold versus other risk-free yielding assets such as sovereigns, and emerging markets such as China started to become major buyers and investors in gold.

Whatever your reason, there have been many great reasons to own some gold over the past 10 years.

Growth of the gold ETP market

Since the launch of GOLD in March 2013, the gold ETP industry has expanded exponentially. Most of the world’s top ETP issuers now have at least one physically backed gold ETP, and there are around 54 physical gold ETPs traded on 35 stock exchanges, trading around $2 billion per day. 97% of these products are exposed to the US dollar gold price, with 3% being hedged into a range of major currencies but primarily the Swiss franc and the euro. 61% of gold ETP assets are due to products listed in the US, with 19% in Europe (excluding Switzerland) and 16% listed in Switzerland.

In addition, there are now around an additional 70 Exchange Traded Products (often referred to as ETCs) tracking spot gold or indices based on gold futures, which make up around $2.5 billion of assets under management. The main gold futures indices include the NASDAQ Commodity Gold Index and the S&P GSCI Gold Index, and these index providers are the world’s leading mainstream providers of financial indices. These ETCs provide a range of gold investment exposures, including currency hedged, short and leverage.

The gold ETPs and the development of the global ETC market

When the world’s second gold ETP – Gold Bullion Securities (GBS) – was launched in London by a company that would later be known as ETF Securities, it was not listed as a fund but as a collateralised note backed 100% by allocated gold bullion. These products are now commonly referred to as Exchange Traded Commodities (or ETCs). GBS in London was not able to be listed as a fund (or ETF) since European fund rules did not allow investment in commodities, while a fund also has to meet certain diversification requirements – of which an investment in gold only obviously does not conform. Thus, the ETC or ETP market was born where ETF-like products could be created, providing access to products not eligible as a fund. The global ETC market thus grew from a single gold ETP to a market that now includes products tracking more than 30 different types of commodities and sectors with around $200 billion of assets (including gold). At $130 billion, gold dwarfs all other commodities.

What is surprising is that the original GBS in London was restructured and relaunched four months after the initial listing. In normal circumstances, this would have spelt the death knell for a new company and new product coming to market, but such was the demand for gold and the GBS, that it was only a wrinkle, and from which spurned a $30billion asset manager.