For traders and investors, as well as for households around the world, gold is viewed as the ultimate protection (i.e., hedge) against inflation. When governments in developing, emerging, or frontier markets, debase their currencies, households turn to gold.
Investing in gold takes various shapes. One may own the physical stuff (e.g., jewelry or bullion gold), own shares in a gold mining company (paper gold), or even shares in an ETF (Exchange-Traded Fund). Out of the three, the cheapest and most convenient way of owning gold is via an ETF.
An ETF is a pooled investment and operates as a mix between a closed-end and open-end fund. The most famous for the gold mining industry is the VanEck Vectors Gold Miners ETF, or simply GDX. It tracks the overall performance of fifty-two major companies in the gold industry, and an investor in GDX will gain exposure to the most relevant companies in the industry.
Advantages and Disadvantages of Owning Shares in an ETF
The biggest advantage of trading and owning ETFs is the cheaper cost. Normally, to invest in a pooled investment fund (ETFs are nothing but a form of mutual funds), one needs to come up with $1 million or more for hedge funds and private equity funds, $100,000 for a separately managed account, and so on.
ETFs solve this problem, as one can own shares in an ETF for as little as $50. Thus, an ETF is viewed as the cheaper alternative for pooled investments, appealing to the retail trading community.
The rule of thumb when investing in shares of a gold miner is that the miner’s profit increases with the price of gold. Hence, instead of owning the physical metal, one may decide to buy shares in a miner and enjoy the dividend. But shares may be expensive, whereas an ETF may solve that issue as well – the price of an ETF, in this case, the GDX, depends on the weights of the index (GDX is a market-cap weighted index) and the performance of its main components. On the flip side, when the price of gold declines, the miners are the first ones exposed.
To be in the GDX, a company must derive at least half of its revenues from gold mining activities, have a market capitalization bigger than $750 million, and a daily average volume of over fifty thousand shares. Therefore, by owning a share in the GDX, an investor gains exposure to the best companies in the gold mining industry and diversification benefits in a way difficult to obtain by trading the individual shares of each company.