Instead of owning physical gold, silver, platinum and palladium coins and bullion outright and storing and insuring these precious metals, investors can buy shares in an exchange traded fund (ETF), commodity (ETC) or note (ETN). As the name implies, these securities are traded on an exchange. Many ETFs and ETCs are backed by real bullion. ETNs are unsecured synthetic instruments and do not store metal bars or ingots.
Gold, Silver, Platinum and Palladium ETFs, ETCs and ETNs are Volatile
Precious metals ETFs, ETCs and ETNs are investment pool trusts that sell shares, the prices of which directly or indirectly track metal bullion prices. Shares are offered by prospectus, like mutual funds, but are not regulated the same way. Exchange traded securities are as price-volatile as the precious metals they shadow, and carry at least the same risk.
Most ETF, ETC and ETN shares are listed on regulated exchanges, just like stocks and mutual funds. Investors can buy and sell their shares quickly online with an ordinary brokerage account.
How Bullion-Backed Precious Metals Exchange Traded Funds are Structured
A "pure" bullion-backed ETF or ETC is a trust that stores tons of physical metal in vaults and offers proportional ownership–shares–in the pool of bullion. Investors each own a fractional interest in the bullion. Investors buy and sell shares on exchanges such as the NYSE. Unlike corporate stocks whose share prices reflect many factors–actual and projected profit, new product development, etc.–ETF share prices hinge on one thing: the metal's bullion price.
A share price's NAV, or net asset value, tracks the physical commodity spot price, which is quoted and traded in troy ounces.* Real bullion bars, ingots or plates, stored in secure locations in London, Switzerland and elsewhere, back up the fund.
These funds seek to replicate the performance, net of trust expenses, of the price of bullion. Shares may represent 1/10 troy ounce, so their prices will be close to, but seldom exactly, 1/10 of the spot or settle price. For example, if gold bullion trades for $1,100 an ounce, a gold ETF will tend to trade at about $110 a share.
How Non-Bullion-Backed Precious Metals ETFs, ETCs and ETNs are Structured
Some trusts are not secured by physical bullion. These are technically derivatives–they derive their value from the value of something else. Unsecured trusts are sometimes issued by a bank, and may be valued in several ways: based on an index of several ETFs; the performance of a group (basket) of futures contracts; the metal's daily closing price on the COMEX exchange; or the daily "London fix." The safety of a non-bullion-backed instrument largely depends on the integrity of the institution (issuer) behind it.
Gold and Silver Exchange Traded Funds, Commodities and Notes
Gold and silver are the world's most popular and widely traded precious metals, so trusts in these sectors have the longest history. There are many choices of U.S. and international funds, ranging from pure bullion-backed plays (e.g., NYSE Arca: GLD, SGOL) to more exotic unsecured leveraged ETNs that, for example, rise in value twice as quickly as silver's bullion price falls (NYSE Arca: ZSL).
Platinum and Palladium Exchange Traded Funds
There are fewer choices of ETFs for these two metals compared to gold and silver. U.S. bullion-backed platinum and palladium ETFs, introduced in early 2010, are traded on the NYSE's Arca exchange (PALL and PPLT).
Investors should read the prospectus and realize that these are speculative plays that may lose money. Caution: a trust designated as an ETF may be unsecured, i.e., have no physical bullion backing it up. As prospectuses for all these funds imply, "let the buyer beware."
* One troy ounce = 1.097 ordinary (a.k.a. avoirdupois) ounce.
George Daleiden - I was a science major in college and later a career member of the Institute of Food Technologists. I worked in the processed food and ...
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