Gold ETF to Test Retail Investor Demand


An impending Exchange-Traded Fund based on gold is stirring debate over whether it will make gold so easy to own that a flood of new retail investors will send the precious metal skyward. Not all gold watchers are convinced, but the timing is intriguing as global political relations strain and deflation threatens assets everywhere.

Most individual investors today buy gold indirectly through stocks of mining operations or in the form of coins or bullion. Gold industry consortium World Gold Council hopes the impending launch this year of its Equity Gold Trust (NYSE:GLD) will attract a new breed of retail investors who want direct exposure to gold in their portfolio without taking delivery of actual gold bars.

"It could be very bullish for gold because I think it will be used for efficient portfolio diversification," said Jay Taylor, editor of J. Taylor's Gold and Technology Stocks newsletter. "People should really be owning gold, at least a little bit of it, because it is so negatively correlated to equities and bonds and the dollar, even more than real estate. It doesn't take much gold buying to drive the price up. The amount of gold in the world is miniscule compared to the amount of paper sloshing around."

Unless the new ETF drums up new customers it could be a hard sell among many of today's gold buyers. Wayne Lemonier, senior account representative at Jefferson Coin & Bullion, a leading bullion dealer, is bullish on gold but said his customers want the security of physical metal. "Owning physical gold is in our view an insurance policy," he said. Against what? "Collapse of the dollar. You can go to Argentina or Mexico or postwar Germany where the Mark became worthless. I had a client who sent me 1,000 German Marks from 1922 and 1923, and they are actually worthless. Had these people converted to gold German Marks they would have preserved all their wealth."

The main argument for the ETF's success is that indirect marketing and distribution in the brokerage industry has hampered gold's adoption by most investors. One Quick and Reilly broker said most retail investors get their exposure to gold mutual funds but noted that these are inevitably baskets of mining operations. For instance, the popular Franklin Gold Fund's top holdings are Barrick Gold, Newmont Mining, Anglo American Platinum ADR, Anglo American Platinum ADR, Harmony Gold Mining and various other South African, Australian and Canadian extraction firms. They have gold reserves in the ground, but how easily they can mine and extract them is at issue.

Aside from buying funds, "most customers want to take physical possession because they view the metal as an investment of last resort when war breaks out," he confirmed.

What would happen if a concerted marketing effort supported the notion of direct gold investment in the form of a security? After a "quiet period" required during SEC scrutiny of its proposed ETF, the World Gold Council is expected to roll out a huge US marketing campaign and to promote heavily to stock brokers.

It's not impossible to buy gold without taking delivery. At coin dealer, for instance, investing in a "pool" of gold pegged to spot markets carries a rather modest 1% spread between buy and sell prices. But the firm is a far cry from being a national brokerage firm with a supermarket of financial services.

Brokerage firms also handle gold sales with futures commodities contracts, and often that requires that an investor be accredited - experienced, tolerant of risk and wealthy.

The ability to buy and sell in a moment's notice, the hallmark of ETFs, is expected to be especially valued by gold investors, since the precious metal recently has been volatile in reaction to terrorism news and uncertainty of global economic recovery. Gold prices started the year above $340 an ounce, jumped to $380 by February, but slid down to nearly $320 only to rise past $360 again by June.

As an asset class the precious metal has a mixed record. It has been negatively correlated with US equities during the past 10 years and thus valuable as a tool for diversification. It has also performed well in the past three years of market turmoil while equities have floundered. But skeptics note that gold has underperformed broad equity markets badly for several decades and is not an engine of economic productivity.

Jefferson Coin's Lemonier feels the threat of deflation carries with it the seeds of increased money supply, universally associated with inflation. "The Fed has so much as said if we are faced with a deflationary period we have this technology called a printing press" to increase the money supply, he said. "They have never said that openly before but they are now."