Do gold ETFs make safe investments?

One hedge fund believes that gold exchange-traded funds offer none of the benefits of owning physical gold, and could even leave you investing in gold that doesn't belong to you. Paul Amery finds out whether this is true.

"No serious professional investor should own gold exchange-traded funds (ETFs)," said hedge fund Hinde Capital once. ETFs offer "none of the benefits of physical gold ownership" and in fact may own "encumbered" gold – the firm says someone else may have a claim on metal that you thought was yours. Does it have a point?

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In fact, the largest UK-listed gold trackers ETFS Physical Gold (LSE: PHAU) and Gold Bullion Securities (LSE: GBS) aren't ETFs at all. They are notes (debt securities) backed by holdings of bullion, and described as 'ETCs'. This choice of legal structure is down to Europe's UCITS rules, which govern investment funds. These rules do not permit a fund to invest in a single commodity, nor to own gold directly (although, confusingly, both non-EU Switzerland and the US do permit ETFs that own only bullion). So are these ways of holding gold safe?

It's impossible to generalise about fund and note structures, but most have common ground. They typically hold almost all bullion in "allocated" form (meaning the custodian holds a certain number of bars that are the sole property of the gold note or fund). So unless you believe the custodian is lying, this gold isn't encumbered. Only when there's a creation or redemption does part of the gold holding temporarily become "unallocated", representing some settlement risk to a market counterparty.

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On its website, ETF Securities (now Wisdom Tree) explains that in the event of its own bankruptcy, its ETCs are ring-fenced, while if the custodian of the gold, HSBC, fails, the trustee should step in on behalf of the owners (ie, investors in the ETCs) and take control of the gold. It's fair to point out, as Hinde does, that the ownership mechanism hasn't been tested in a bankruptcy. But to suggest that gold confers none of the benefits of physical gold ownership seems absurd, given that gold ETFs and ETCs have drawn so much money in the last decade for doing precisely that.

There are other ways to own gold. Bullion Vault offers perhaps a simpler holding structure and compares well with ETFs for larger investors and longer holding periods. Or, if you're really concerned about using a financial intermediary, you can buy bullion and store it yourself although you'll incur higher costs (see where to buy gold bullion here).


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