Ride out the gold storm

Gold may have taken a short, sharp knock this week, but the good news for those of us who plan to carry on using gold exchange-traded commodities (ETCs) is that they continue to do their job, tracking the price well and offering great liquidity.

Statistics from the London Stock Exchange show that ETF Securities' Physical Gold ETC (PHAU), which I own, and Gold Bullion Securities (GBS), plus Source's Physical Markets Gold P-ETC (SGLD), consistently rank in the top five exchange-traded products in Britain by trading volume.

That may be because in normal market conditions you can expect to pay three to six basis points (hundredths of a percent) plus brokerage fees for a 'round-trip' where you buy and then sell them. That compares well with the cost of buying gold bullion directly (via krugerrands, sovereigns or bars), where the costs can come to 5% or more.

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The high level of liquidity in ETCs, based on a deep, active market, also compares favourably with other ways of trading gold, such as via a spread-betting firm. Although spread bets can be placed quickly, dealing spreads are probably double those for ETCs.

Another key factor when choosing between the various gold tracker products is counterparty risk. Buying and storing bullion gives you no direct exposure to any financial institution, though you pay for that privilege. At the other end of the spectrum, if you trade via a spread-betting firm you are dependent on its ability to honour the bet and pay up.

With Financial Conduct Authority-authorised spread-betting firms, you are covered for up to £50,000 of exposure via the UK Financial Services Compensation Scheme (FSCS). Beyond that, you will lose money if the firm fails while you have an open position.

ETCs are at the safer end of this risk spectrum. Almost all (including PHAU, GBS and SGLD) own physical gold directly, with just a small exposure to "unallocated" metal. But watch out for the recent crop of currency-hedged gold ETCs that don't own physical gold.

Instead, all they hold is a collateral-backed promise from a sponsoring counterparty to pay it the overall hedged return. So not only are you adding a currency view to your gold position, but you are also taking some extra product risk. That's why the best way to ride out the gold storm is via a more traditional ETC, such as PHAU, GBS, or the cheaper SGLD.

Paul Amery edits www.indexuniverse.eu, the top source of news and analyses on Europe's ETF and index-fund market.