Getting Started With Gold ETFs

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A gold ETF, or exchange-traded fund, is a commodity ETF that consists of only one principal asset: gold. Exchange-traded funds act like individual stocks, and they trade on an exchange in the same manner.

However, the fund itself holds gold derivative contracts that are backed by gold. So, if you invest in a gold ETF, you won't actually own any gold. Even when you redeem a gold ETF, you do not receive the precious metal in any form.

Instead, you as an investor will receive the cash equivalent.

The Investing Principle

Investors use gold ETFs to track and reflect the price of gold. While the assets in the fund are backed by the commodity, the intent is not for an investor to own gold. A gold ETF gives an investor an opportunity to gain exposure to the performance, or price movements, of gold. 

How to Use Gold ETFs

Gold ETFs offer some of the same defensive-asset-class traits as bonds, and many investors use them to hedge against economic and political disruptions, as well as currency debasement. Gold tends to rise when the dollar is weak, so if your investment portfolio holds assets that have risk exposure to the dollar’s downside, purchasing a gold ETF may help you hedge that exposure. Conversely, selling a gold ETF can act as a hedge if your portfolio has exposure to the upside.

A gold ETF is a commodity exchange-traded fund that can be used to hedge gold commodity risk or gain exposure to the fluctuations of gold itself.

If an investor has increased risk on his portfolio assets when the price of gold rises, owning a gold ETF can help reduce risk in that position. Or if after ample research, an experienced investor decides to short gold, trading an inverse gold ETF may be a quick way to add a put to his portfolio for that position.

Broader Uses

While gold is a commodity ETF, it can act as an industry ETF as well. For example, if an investor wants to gain exposure to the gold mining industry, owning a gold ETF may be an investment strategy that can fit his or her portfolio.

While other individual gold-mining stocks like Barrick Gold (ABX) and precious metals indexes like the XAU exist, a gold ETF may be a simpler or more diverse way to make an investment in the gold mining industry. Certain benefits come with ETFs such as hedge protection, making them a useful tool to have in one’s investment arsenal.

Gold ETFs can also be applied as a hedge for regional risk or to gain foreign exposure. If a certain country depends solely on gold as its main source of income, an investor with portfolio assets that have risk in that country can sell, or short a gold ETF as protection. So, if gold drops, the short ETF position can help lessen the investor's loss.

A Few Disadvantages

If you are seeking to actually own a gold asset, you cannot do so through a gold ETF. You never actually own a gold bar, bullion, or coins. Gold ETFs consist of gold contracts and derivatives and can only be redeemed for cash, never gold itself.

While ETFs have many tax benefits, a gold ETF may be at a disadvantage.

In some cases and locations, gold ETFs do not have the same capital gain tax breaks that tradition exchange-traded funds have. So before you dive into gold ETFs, understand how they will affect your tax return.

Most Popular Gold ETFs

You can explore many types of gold ETFs, but before you include them in your investment strategy consider watching the performance of a few of the more popular funds. See how they move and if it works for your portfolio needs. Once you have a better understanding of gold ETFs, you'll likely find it easier to get started investing in them. The following represent some of the more well-known gold ETFs:

  • GLD - SPDR Gold Trust ETF
  • IAU - iShares COMEX Gold Trust ETF
  • DGL - PowerShares DB Gold ETF

A diverse variety of other gold and precious metal ETFs exist in case you choose to research additional gold ETF options.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.