ETF vs. Mutual Fund: Two Ways to Invest in Gold Miners

Whether saddled to mutual funds like Fidelity Select Gold (FSAGX) or ETFs like Van Eck’s Gold Miners Index (GDX), gold investors have experienced a wild ride over the last year. While the recent volatility in gold prices is certainly enough to give investors pause, a good argument exists for the presence of a gold ETF or mutual fund in a well-diversified portfolio. Both FSAGX and GDX help investors mitigate the pitfalls of falling currencies and economic slowdowns. Since gold is a physical asset, it tends to maintain its value over time, giving wary investors an added measure of security as time-tested institutions vanish in the face of economic crisis.

FSAGX and GDX both invest assets in companies that are primarily engaged in the exploration, mining, processing and dealing of gold. As of FSAGX’s semiannual report in November 2008, the fund held seven out of ten of the same top ten holdings. While GDX tracks the NYSE Arca Gold Miners Index, comprising 32 small, medium and large companies incorporated in any gold index, FSAGX is managed by Joe Wickwire and is composed of 69 holdings. The similarities between the two funds are striking, but some investors prefer having a human, rather than an index, at the helm. The larger number of holdings in FSAGX also means a smaller concentration of assets in top holdings, reducing the exposure that investors have to any one portfolio component.

The top component for both FSAGX and GDX is Barrick Gold Corp. (ABX), constituting 13.77% of GDX’s portfolio as of January 13 and 9.5% of FSAGX’s portfolio as of late November 2008. The Toronto-based exploration company holds interests in a variety of gold resources in South America, Africa and Australia. At the end of 2007, ABX had 124.6 million ounces of proven and probable gold reserves, 1.03 billion ounces of contained silver within gold reserves, and 6.2 billion pounds of copper.

Goldcorp (GG), the second-largest holding for both GDX and FSAGX, saw shares battered with a series of downgrades and target price reductions in early January, after releasing lower guidance for 2009. Some analysts, however, have dismissed the tarnish to Goldcorp’s shares as an overstatement of the reality of an industry-wide slowdown. In GG’s latest report, the adjusted forecast calls for 50% growth in production through 2013—only 5% lower than analysts’ estimates. In 2008, GG produced a hefty 2.3 million ounces of gold, achieving low margins on a scale larger than those of other competitors such as Yamana Gold (AUY) and Agnico-Eagle Mines (AEM).

While the most obvious difference in deciding between an ETF and mutual fund is the fees associated with the two different investments, investors should consider several factors when choosing FSAGX or GDX. Even though the expense ratios of both funds are well below the category average—FSAGX is 0.86% while the ratio for GDX is 0.59%—many investors have gravitated to the ETF fund in recent years for the additional edge.

Investors who own FSAGX will have to hold shares of the fund for longer than 30 days in order to avoid a 0.75% redemption fee—a nerve-racking setback for nervous investors who prefer the option of getting in and out of investments quickly. As opposed to the once-a-day pricing method of mutual funds, ETFs like GDX trade continuously throughout the trading day, but this flexibility also brings an increased measure of volatility. ETFs tend to be more affected by changing news events than mutual funds are, causing surges and dips in price avoided by comparatively steadier mutual funds.

The differences between GDX and FSAGX are more apparent when comparing fund performance in recent months. GDX dropped more than 63% from July 14, 2008, to October 28, 2008, but it has since recovered 35%. FSAGX, however, fell only 60% from July 14 to October 28 and has recovered 36% in the period since. While their price movement is relatively similar, investors fearing intraday volatility may feel more comfortable with FSAGX than GDX, especially given its longer track record.

While putting assets into gold could prove to be a profitable move for many investors, it is important for prospective GDX and FSAGX buyers to keep the role of this commodity in perspective. With the ultimate success of gold investments weighing heavily on continuing inflation concerns, placing a bet on gold—or any narrow sector—could whipsaw investors as the inflation battle takes shape under the new administration. For those investors seeking the added security that gold could add to their portfolios in 2009, both GDX and FSAGX, with their solid track records and investor interest, are good places to start.

Comments

[secmaven:]

Gold mining stocks have never ceased to amaze me. Here is an industry that:

1. Pays essentially no dividends,
2. Produces a wasting asset,
3 Is under world wide siege from environmentalists
4 Faces expropriation threats from a change in the political climate
5. Has to placate an often truculent work force
6. Must constantly replace its physical production capital at higher and higher
cost

And yet every time the price of gold moves up a few percentage points the stocks in this industry take off for the moon and then quietly come back to earth as the reality sets in. Even if gold would go up 50%, the actual economic benefit to the shareholders will be zip, nada, nothing.

Buy gold or a double geared gold ETN. Forget the stocks.

Jan 23 11:35 AM

[silverwood:]

Although I agree with the author that buying a gold mutual fund or gold ETF is a good idea, this should be done after you have in your possession the physical metal (gold and silver). The physical metal is insurance against a currency collapse, or severe devaluation.

I disagree with the author's view that gold is just a commodity and it's valuation is only derived from fear of inflation. Gold is a currency and trades as such. Gold is real, natural money.

AS for the choice of investment the authors has suggested FSAGX, the mutual fund would be better for those investors who are seeking long term buy and hold stratergy, while GDX, the ETF would be better suited to those more prone to trading. Personally I would suggest some exposure to the junior explorers as that sector has been completely trashed and careful due diligence on selected companies could prove the greatest rewards.

Jan 23 12:03 PM

[Ishortyou:]

buy the gold itself, federal central banks or just central banks around the world are realizing that the dollar as a reserve its not trustworthy, instead they are going to be switching to old school 'gold reserves' as more trustworthy, so having gold in hand would be probably better than having dollar on hand.

Jan 23 12:11 PM

[Bill Thompson:]

this guy been bullish on gdx all year, crashmarketstocks.com

Jan 23 02:47 PM

[d_teller:]

Just a short correction to the comment by "secmaven" above, regarding- "essentially no dividends"...FSAGX has paid about 2%/yr in the Spring of each year, and I've held it for 30+ years. Of course, if one bought it at $15.87 when it was way down last Fall, rather than at $69, last Spring, the dividend would seem even larger. But "secmaven" is mostly correct about little payouts, but over time 2%/yr does increase the # of shares (and this excludes some large end-of-year payouts of these "sector" funds in some of the prior years).

Jan 23 10:25 PM

[Bruce Pile:]

Gold stocks are typically thought of as a one dimensional play on inflation. But there is more to it than that. For example, in the start of the Depression with deflation raging, gold stocks did a fabulous climb. And it started even before FDR fixed the price of gold keeping it from possible deflation.

Gold seems to respond more to chaos and uncertainty than to the current inflation rate. After all the debate on CDS, bank conditions, deflation, and inflation, there is only one form of money not subject to any personal liability anywhere and thus not subject to default - gold.

Jan 24 10:39 AM

[Bruce Pile:]

An added thought to the above on gold stocks, there was a very fundamental reason for them doing well in past bull runs. Homestead Mining's stock climbed, but also their earnings and dividend payout climbed at something like a 40% annual rate over the first few years of the Depression. If they were selling clothespins as their business, their stock would have done well! It was not just crazy fear-mongering speculation.

If you look at the charts and valuation by cash flow of gold stocks today, you see quite a collection of what you would have to call pure value plays. The price-to-cash flow numbers of many gold stocks are running well below the average for the S&P 500. But unlike most of the rest of the stock world, their product is not suffering severe demand destruction. Yet the gold stocks have received the same thrashing, even worse, than the rest of the market.

Jan 24 11:29 AM

[Conan the B...:]

Goldfinger AKA Geithner gave us a preview of what will happen in the future if he is approved.

Gold went up but little else changed.

The next time around when he IS the Sec. of the Treasury, it will be far, far worse.

The next time, expect the USD to tank, the Stock Market to out do the 1987 crash and Gold to really skyrocket.

I would not advise holding physical Gold in the USA as it will probably be illegal to own it privately. Whether it gets down to the Jewelry and Coin level is moot.

Geithner's idiocy can be applied across the entire currency spectrum. China is front and center now, a political toy. But what happens if the USD cannot compete against the Euro in the future?

Jan 24 01:50 PM

[Conan the B...:]

A strong USD is not in the best interests of the US Economy.

The International US companies cannot compete with Nations whose companies are not saddled with health liabilities inherent in the salaries of US Company employees. To obviate the differential, the USD Must Drop.

Risk Aversion promoted the USD as a "safe" haven. It isn't but perception and "Reserve" currency status is enough at this point.

If the "house of cards" collapses, I would feel safer with the Central fund of Canada(CEF). While it is primarily a silver play ( 50 to 1 ratio), it is a depository of physical Gold and Silver outside of the US.

I do not trust the US monetary authorities to allow Gold ownership if the USD proceeds down to my ultimate target of 40.

Caveat, the 40 target is 3-5 years into the future, USD is moving UP presently.

Jan 25 12:42 PM