The Best Options For Owning Gold

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Includes: DGL, DGP, DGZ, DZZ, GEUR, GLD, GLDI, GLL, IAU, OUNZ, PHYS, SGOL, UBG, UGL, UGLD
by: Daryl Montgomery

Summary

There are many options for owning gold, and the best one is not the same for all investors.

Investors can use ETNs, ETFs, unallocated or allocated storage, and coins and bars.

Only one ETF option offers average investors the same opportunities that institutions usually get.

Physical ownership is not only the most costly option, but also has some risks.

For many years, some gold bugs have not trusted gold ETFs, claiming they don't really have the gold they are supposed to have in storage. News just prior to Labor Day weekend that Deutsche Bank (NYSE:DB) initially failed to satisfy a delivery request for physical gold from its Xetra-Gold exchange-traded product [ETP] exacerbated these fears further. Gold investors have many options in owning gold, and physical ownership is not the only alternative to ETPs.

ETPs themselves can be divided into two categories - ETFs and ETNs - and the most worrisome category is not the one most gold bugs usually criticize. They should be worrying more about ETNs, not ETFs. ETNs (exchange-traded notes) are merely financial obligations of the issuing company. There is no physical product backing them. They only maintain any value if the issuing company remains a going concern. In the Lehman bankruptcy, some ETNs wound up losing their value along with the company. These investing vehicles should be avoided in any environment where bank failures are a risk. This is the case in Europe and the UK at the moment, but only for select banks. Deutsche Bank is one of the EU's most troubled banks. For more about bank risks in Europe see "Zombie Banks: Low Price/Book Ratios Characterize The Walking Dead" and "European Banks: Will They Drag Down Global Markets Again?" Gold ETNs include: DZZ, DGZ DGP, GLDI, UBG, and UGLD.

ETFs offer more protection, and some of them are backed by physical gold. Obviously, no ETF that offers short or leveraged exposure could have gold backing. These ETFS use futures or forward contracts. GLL and UGL are examples of this. GEUR and DGL also use them, even though they don't provide short of leveraged exposure to gold. An investor who wants a gold ETF that is actually backed by gold has four choices: GLD, IAU, SGOL, and OUNZ. There is also a closed-end fund, PHYS, that holds physical gold.

They all keep gold in different locations. GLD and OUNZ store gold in London, SGOL in Switzerland, PHYS in Toronto, and IAU in London, New York, and Toronto. Generally, gold ETFs avoid storage arrangements in the United States because the U.S. government confiscated private gold holdings in the 1930s and the Supreme Court ruled such confiscation legal. While it is not likely to happen again, the legal underpinnings that would make it possible are still on the books.

Some investors can redeem their physical gold from GLD, IAU, and PHYS, and in theory, any investor could do this from OUNZ. To redeem gold from GLD, it is necessary to do so in 100,000-share lots. This represents 10,000 ounces of gold, or $10 million worth of gold, if the metal is selling for $1,000 an ounce. This is clearly prohibitive, except for institutions. IAU is a little more reasonable, with the minimum amount for redemption being 50,000 shares or 500 ounces of gold. This is still $500,000, if gold is selling for $1,000, so this option is still only available to institutions and the very rich. PHYS allows redemptions in increments of London Gold Delivery bars, which vary from 350 to 430 ounces, so the amount is almost as high as it is for IAU.

Unlike the others, OUNZ allows for redemption of as little as one ounce of gold and offers various choices of coins and bars. The redemption fee, though, is around 100-200% for one ounce of gold. So, in reality, this is not practical for small amounts. At the higher minimum fee, an investor would have to redeem over $50,000 of gold to pay around 5%. This is a viable option for many investors.

Is redeeming gold actually necessary? If an investor thinks so, OUNZ is obviously the best deal except for small amounts. For quantities much less than $50,000, buying gold directly from a reputable coin and bullion dealer, a mint or bank that sells directly to the public and then storing it in an appropriately safe place would be the best option. While there is no possibility of fraud with mints, they usually don't usually offer the best prices. Dealers offer better prices, but there is some small chance of winding up with counterfeit merchandise (such items frequently appear on the market, and are usually tungsten with a coating of real gold). Of course, direct ownership of gold in any form doesn't offer protection from government confiscation.

Counterfeit 10-Ounce Gold Bar Sold in NYC in 2012

An alternative would be to own gold in unallocated or allocated storage. The storage for PHYS and OUNZ is specifically listed as allocated. Allocated storage means there is ownership of specific gold bars or coins that are usually kept segregated from other gold in the same storage facility. Unallocated storage indicates that a specific amount of gold is owned, but not specific bars or coins (sort of like money deposited in a bank is mixed together with all the other money). Allocated storage is more expensive than unallocated storage and provides stronger ownership rights in case a storage facility runs into financial difficulties.

From a cost perspective, unallocated storage is preferable. It can even be free. It does have risk with a private enterprise, such as a bank, but not with a government entity. Banks in Switzerland use to routinely offer this service, but have moved away from it because of pressure from foreign governments, who claimed it was because used by tax scofflaws. The Royal Canadian Mint offers this service, but only to institutions. The Perth Mint, wholly owned by the government of Australia, offers it to individuals and doesn't charge. Allocated storage usually costs around 1.5% per year, a much higher rate than the management fees for any gold ETF.

When investing in gold, convenience, safety, and costs all need to be balanced. For investors who think the risk of default by a gold-backed ETF is so minimal that it can be ignored, IAU seems to be the best choice (it has lower management fees). For those who have some concern, OUNZ meets their needs. It provides the advantage of allocated storage, but at a much lower cost. American investors who don't want to own physical gold that is kept within the U.S. can consider the Perth Mint unallocated storage option. Those who want to just buy a few coins should realize that buying and reselling transaction costs can be high.

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

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.