GLD vs. IAU: Which Gold ETF Is Best?

Gold has been a popular investment destination for decades, thanks to the appeal of this precious metal as a way to diversify portfolios, hedge against inflation and the U.S. dollar, or simply to speculate on increased interest in safe haven assets. Many big name investors, like George Soros, have long praised the benefits of gold investing and the handsome returns that it is capable of offering. But being a precious metal, gold is not easily accessible to all investors, as its price has increased significantly over the past few years, with the yellow metal holding a firm grip about the $1,500 per ounce mark for the last several months [see also Gold ETFs 101: Dozens Of Ways To Play].

In recent years, ETFs have become extremely popular tools for establishing access to gold. ETFs have allowed for the everyday investor to allocate their resources to gold without emptying their bank accounts, or dealing with the risks of physically holding the metal themselves. Various exchange traded products offer exposure in several different strategies; investors now have the option to invest in stocks of gold miners, futures-based gold ETFs, and leveraged and inverse products as well [see Precious Metal ETFs: Physical vs. Equity Exposure].

But the most popular means of establishing gold exposure through ETFs involves physically-backed ETFs, which hold a number of advantages over other strategies for accessing gold. The appeal is quite simple; because the underlying assets are bars of gold bullion, the value of physically-backed gold ETFs should move in unison with changes in spot prices. One of the biggest draws  to these products is the issues they avoid that popular futures-based funds have long been saddled with, including the ultimate value-killer: contango. Another major attraction is the simplicity of the products; they own the metal itself, no complex gimmicks or investment strategies. While there are several physically-backed gold products, none have gained the popularity that SPDR Gold Trust (GLD) and iShares COMEX Gold Trust (IAU) have amassed.

GLD and IAU are similar in nature; both offer exposure to gold bullion stored in secure vaults, and as such both should move closely in unison with the spot price of gold. But that doesn’t mean that these ETFs are interchangeable. There are several subtle differences between the two that may not be immediately obvious, yet are still capable of creating a unique set of risk/return profiles [see also Soros Dumps Gold ETF Assets].

1. Expenses

The first major differentiation between these two products comes in expenses. In the summer of 2010, iShares cut the expense ratio on IAU from 0.40% to 0.25%, seeking to set the product apart from its much larger competitor. Meanwhile, GLD currently charges an expense ratio of 0.40%. That 15 basis point gap won’t have a big impact on some positions. For investors looking to invest $10,000, the annual dollar differential works out to about $15–hardly a total that will make or break your retirement portfolio. But for investors looking to maintain a position in physical gold for the long run, or for those with much larger positions, the impact of this expense ratio differential can be substantial [see also TBAR: Too Expensive Or A Great Bargain?].

2. Price / Metal Entitlement

The price discrepancy between these two ETFs may jump out at some investors: IAU is currently priced around $16 per share, with each share in the fund representing approximately 1/100th an ounce of gold. GLD, on the other hand, is priced around $160 per share, with each representing about 1/10th an ounce of gold. In other words, to get the same amount of physical gold exposure, investors would have to purchase ten times the number of shares in GLD as they would in IAU [see also 50 Excellent Tools, Resources, and Blogs For Gold Bugs].

The price of an ETF is somewhat arbitrary; it takes little additional effort to purchase 10 shares of IAU for every one share of GLD. But the “handle” of these ETFs may have an impact on the costs of establishing a position. Suppose that there are penny-wide spreads for both ETFs, a relatively save assumption given the huge volumes in each. For IAU, that works out to about .0678% of the price. For GLD, it’s a much smaller .00681%. It’s a minor difference, but one worth noting; for large investors placing big trades in a physical gold ETF, it may be cheaper to execute a position in GLD–even though the expense ratio is higher in the SPDR.

3. IAU: 100% Allocation

Buying into a physically-backed ETF, most investors would assume that all of their money is going towards the physical ownership of gold bullion, but this is not always the case. IAU features 100% daily allocation, while GLD is just barely off that mark. So what can happen to a fund that is not exhibiting 100% allocation? For starters, allocation is the process of transferring the ownership of new gold from the custodian to the trust. When the trust needs to issue more shares to meet investor demands, they use a process called creation, whereby new gold is delivered to the custodian who is then supposed to allocate the bullion to the trust, but this does not always happen immediately [see also Gold Miner ETFs: Breaking Down All The Options].

When there is a discrepancy between the gold owned by the trust, and the gold that was supposed to be delivered by the custodian, unallocated gold is created. This is an important issue to note, because if there is ever a dispute between trust and custodian, or if the custodian endures financial problems, the shareholder’s of that particular fund can be “exposed to losses in the amount of the gold in the unallocated account,” writes the iShares Blog. “If a negative event were to happen on a day when there was a large creation of new gold ETF shares, investors could be exposed to substantial losses.”

While the difference in allocation between IAU and GLD is very minor, it is a risk that investors should be aware of before buying into shares of either product.

4. Liquidity

While both funds are extremely liquid, the discrepancy between average daily volume may be worth noting for certain investors. IAU trades just under 5 million shares daily, compared to GLD’s near 15 million shares exchanged daily, giving GLD three times the liquidity of its competitor. Of course, there is a law of diminishing returns with liquidity; investors should be able to get penny wide spreads in either product. Moreover, the creation / redemption mechanism in place under ETFs makes average daily volume largely irrelevant when discussing liquidity of an ETF.

While the difference in liquidity between the two ETFs is minimal, it is worth noting that the options market for GLD is considerably more liquid than the options market for IAU. For some investors implementing relatively sophisticated strategies, that distinction might be worth noting.

Verdict

Both of these products are solid investments for those looking to add exposure to gold bullion to their portfolio, but there are subtle differences that make one fund better for certain types of investors as opposed to others. For the more cost-aware, “buy-and-hold” investor, IAU’s low expenses and 100% allocation make it a safer bet for a long term hold. Because of the materially lower expense ratio, IAU is virtually guaranteed to outperform GLD over the long run; investors who pick the gold SPDR are exchanging return for brand recognition [see also Eight Legendary Gold Investors].

While we think IAU is the best choice for the majority of investors out there, we do acknowledge that a position in GLD will make much more sense for certain large investors looking to achieve the most efficient execution possible. Unless you fall into that minority, IAU is probably the best bet.

Disclosure: No positions at time of writing.

This entry was posted in ETF Comparison, Physical Gold ETFs and tagged , . Bookmark the permalink.

Leave a Reply