Best Potential Returns: Gold ETF Or Gold Miners ETF?

by: Waterbury Research

ETF investors or traders looking to take a position on the value of gold have a range of choices from the various ETF providers. This discussion concerns the choice between the two basic types of gold exchange traded funds: ETFs which track the spot price of gold and the ETF's which hold shares of gold mining companies. The gold ETFs - those tracking the price per ounce of the shiny metal - have become so popular, some ETF investors may not be away funds exist which invest in gold miner stocks.

The Players

The ETFs which directly track the spot price of gold do so by owning gold bullion to back the ETF shares trading on the markets. The available bullion ETFs are the SPDR Gold Trust (NYSEARCA:GLD), the iShares Comex Gold Trust (NYSEARCA:IAU) and the ETFS Gold Trust (NYSEARCA:SGOL).

The choices of gold miner ETFs include the Market Vectors Gold Miners ETF (NYSEARCA:GDX), the Market Vectors Junior Gold Miners ETF - (NYSEARCA:GDXJ), the Global X Pure Gold Miners ETF (NYSEARCA:GGGG) - and the Global X Gold Explorers ETF (NYSEARCA:GLDX). Of these funds GDX and GGGG hold the large gold mining companies producing large amounts of gold and GDXJ and GLDX hold smaller companies who primarily search the world for new gold finds with the goal of becoming or selling out to one of the major gold mining companies.

Pros and Cons

The gold bullion ETFs provide investors and traders any easy way to participate in the changes in the value of spot gold. Instead of buying bullion or coins and locking them in the basement or setting up an account with a bullion company, an investor buys the ETF shares through a discount brokerage account. The bullion ETF investor can participate in the dollar for dollar rise in gold and catch the benefits of gold as an inflation hedge. The downside of bullion investing is there is no support if the price of gold drops or no gains if gold goes nowhere. The bullion ETFs can be viewed as a long term hold on gold or a trader can use timing to catch the upswings in the price of gold.

Gold mining stocks and the ETFs holding the stocks are considered a leveraged bet on the price of gold. If a miner earns $100 per ounce when gold is at $500, his profits double if gold goes to $600. In theory, gold miners should outperform gold as the price rises, due to this leverage effect. Gold mining companies can also pay dividends, boosting the potential return and providing an investor with an income stream from his gold investment. Also, gold mining companies can grow profits even when the price of gold is flat by producing more gold and lowering expenses. The downside of gold stocks is the share prices may follow the overall stock market into a bear market, even if the price of gold is climbing.

Picking Your Investments

The reality is the gold miners have seriously under performed the price of gold. Over the last five years, from early 2007 to early 2012, the gold bullion ETFs increased by 160 percent and the only gold miner ETF that old (GDX) gained just over 40 percent. And the dividends paid by the gold miner ETFs are disappointingly low. It is understandable why the investor and trader money has gone into the bullion funds. One change on the horizon is the realization by the gold miners that their shares have under-performed. These companies have been discussing increased dividend rates and other methods to boost shareholder returns. The gold miner ETFs came out with a hot start for the first five weeks of 2012, matching or beating the 10 percent gain in spot gold. Investors should consider putting a portion of their gold investment into one or two of the gold miner ETFs.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.