How safe is your gold fund?

Gold exchange traded commodities are commonly used by investors to help diversify their portfolios. Royal Mint Physical Gold ETC provides heightened security and 100% responsibly sourced gold.

The value of investments can fall as well as rise, and you may get back less than you invested. Past performance is no guarantee of future results

How to buy gold

Gold is the asset that inspires the desire to own more. Since 2001, the market for gold has increased by an average of 14% a year driven by new ways to invest and growing demand for gold from newly affluent middle classes in emerging markets like China and India.

This rare metal has been used for millennia as a currency, a status symbol and, for investors, a store of wealth, an inflation hedge and a safe haven in times of crisis - characteristics that help explain why demand for gold goes into overdrive whether troubles occur in the equity markets such as coronavirus, or in the case of bond market crises like the global credit crunch.

But while gold is now a core holding in many multi-asset portfolios, there are many ways to own it, each bringing different benefits and risks.

  • Physical gold bars and coins: small bars and coins enable investors to own physical gold metal, but the investor bears the security risks and costs
  • Bullion bars: at 400 oz, these bars are used by many large institutions as a way to own gold. London ‘Good Delivery’ bars are the global standard but are often too large for individual investors. The holder of the bar will typically bear the costs of safe keeping and delivery
  • Gold mining stocks: investors can buy shares in gold mining companies. However, the company’s share price may not track the price of gold and the investor will not own any physical metal
  • Physical gold exchange traded commodities (ETCs): ETCs are backed by physical gold and allow investors to track the price of gold, giving them access to the properties and security of owning physical gold without the need to arrange for storage and insurance separately

Physically gold-backed ETCs have been an investor a particularly popular way for investors to own gold during the recent coronavirus panic. As of June, a record 3510 tonnes of gold are now owned via ETCs by both institutions and individual investors - a huge jump from 3033 tonnes in February this year.

In a physically backed gold ETC, the gold is held on behalf of the investor in the vaults of a custodian bank. Many investors seek to spread their risk by buying multiple Gold ETCs from different issuers, on the assumption that their golden eggs are in different baskets, but does this strategy make sense?

The table below shows four physical gold ETCs listed on the IG platform:

Gold ETC Tickers CCY Custodian TER Responsibly sourced Optional Physical delivery
Royal Mint Physical Gold ETC RMAU
RMAP
USD
GBP
Royal Mint, Wales 0.22% 100% Yes - bars & coins
iShares Physical Gold ETC IGLN
SGLN
USD
GBP
JP Morgan, London 0.19% Not published No
WisdomTree Physical Gold ETC PHAU
PHGP
USD
GBP
HSBC, London 0.39% Not published No
Invesco Physical Gold ETC SGLD
SGLP
USD
GBP
JP Morgan, London 0.19% Not published No

Risk one: are all your golden eggs in the same basket?

Before we go further, as far as we know, we should point out that there’s not been a successful robbery of any bank associated with gold ETCs – but that doesn’t mean that it couldn’t happen, or that some other disaster could befall an issuer or custodian. It’s also not impossible that fraud, malfeasance or a criminal employee could result in the loss or theft of gold.

If the point of holding gold is to hedge against a worst case scenario, then investors need to have a strategy that ensures their gold is stored in a way that is metaphorically and literally ‘nuclear proof’. Perhaps proof of the potential for a crime is the fact that most custodian’s insurance doesn’t cover the value of all the metal they custody just the amount the insurance company estimates someone can steal at one go.

Diversification is usually the best way to spread risk so it’s important to understand what true diversification means when it comes to gold custody.

It’s easy to assume that if you bought two or three different gold ETCs that you would be diversified, but gold is gold and it really matters very little who the issuer is - their role is really limited to just operations and marketing of the product.

Additionally, most issuers are (part of) listed companies that are highly exposed to the ups and downs of global equity markets, creating an additional source of risk. For gold ETCs, real diversification come down to where the gold is stored and held.

The largest gold ETCs do not store their own gold but instead rely on banks – shareholder-owned commercial entities – to provide custody. In fact, more than two-thirds of gold held by ETCs is stored in the London vaults of just two banks – HSBC and JP Morgan. So even if an investor chooses to diversify their gold holdings by buying different gold ETCs from different issuers, the gold is likely to be stored in one of these banks’ vaults.

The failure of these institutions, or a serious attack on London, could be catastrophic for holders of these gold ETCs. The 2008-2009 financial crisis illustrated that there is no such thing as ‘too big to fail’.

Here, it’s important to say that both of these banks are two of the most secure institutions and are highly experienced precious metal custodians, but investors seeking true diversification could consider a gold ETC where the gold is stored outside of the commercial banking system.

Risk two: ESG investing and responsibly sourced gold

Given the critical role gold has to play, how can investors with environmental, social and governance (ESG) goals include gold in their portfolios?

A company incurs ESG risk because of what it makes, but for gold the main point of ESG risk is in the supply chain - how the gold was extracted, who profited, the treatment of miners and supply chain labourers and whether there is a risk that the gold has been used for money laundering, terrorist financing or supporting war.

Identifying the provenance of gold is made more difficult as it doesn’t have a limited shelf life - once a bar is produced it can stay in the gold ecosystem for good, no matter how it was mined, produced, owned or stored.

By definition, there are gold bars in circulation that were mined and smelted in ways that would be unacceptable today. Therefore, investors who enjoy the diversification benefits of holding gold in their portfolio have long pushed the gold industry to provide clarity around the provenance of gold that goes into making the gold bars.

To help, the two main gold industry trade bodies, The World Gold Council and London Bullion Market Association have both established guidelines for responsible gold sourcing. In September 2019, The World Gold Council launched their 'Responsible Gold Mining Principles' – a set of guidelines for miners that covers ten key areas - environmental impact, responsible supply chain, workforce safety, human and labour rights, community impact, environmental stewardship, land use and water & energy use.

The older the ETC being held, the more likely it will have bars that don’t meet the programme’s strict requirements. We believe that over time, responsibly sourced gold will become the standard for gold ETCs, but for older, legacy funds which hold billions of USD in gold bars it will be difficult and take significant time and resources to implement.

As each bullion bar that meets these standards can be identified by a unique serial number, recent ETC launches, like The Royal Mint Physical Gold ETC, can now offer products that invest exclusively in responsibly sourced gold, delivering a solution for ESG investors.

The ‘sovereign’ alternative

The Royal Mint is Britain’s oldest company and tenth oldest in the World. Founded by King Alfred the Great in 886, the company has weathered the Norman invasion, the Black death, multiple civil wars, two world wars, Spanish flu and the Great Depression. While many banks have come and gone, The Royal Mint has an unparalleled history, and through UK Treasury ownership has a credit history and profile that is incomparable to any commercial organisation.

In February 2020, The Royal Mint made history with the launch of its first ever listed financial product – The Royal Mint Physical Gold ETC (RMAU). Like many other gold ETCs, RMAU lets investors buy physical gold as easily as buying a regular share, but unlike almost every other gold ETC, RMAU custodies its gold away from the London banking system in purpose-built vaults on the outskirts of Cardiff in Wales.

Beyond these important differences, RMAU also offers a number of additional features that many existing gold ETCs do not:

  1. Lower cost per ETC: most physical gold ETCs entitle the holder to one-tenth of a Troy ounce of gold but RMAU enables investors to buy as little as one-hundredth of a Troy ounce. This makes it far easier for small investors to buy gold and fine tune their allocations
  2. Flexible redemption and delivery: RMAU lets investors take physical delivery (ownership) of gold as bars or, uniquely to RMAU, bullion coins. The Royal Mint will ship the bullion to an investors home, or any other location, or store the gold securely in the investor’s name. This is physical gold investing in its most tangible sense
  3. Responsible gold: the process of mining and refining gold is rife with ESG risks. Major trade associations like LBMA and World Gold Council have established guidelines for producers and refiners, but many gold ETCs don’t hold gold that meets these rigorous standards. In contrast, as a new ETC, RMAU has to date been able to secure 100% of its physical gold from the LBMA responsible sourcing program, meaning investors who want to build an ESG portfolio now have a viable gold solution

RMAU provides a genuine alternative to the same old ETC providers and, more importantly offers real diversification at the custody level. For many investors in gold, safety is the number one priority and RMAU delivers physical security in a geographically separate location alongside other important differentiating features.

As with all exchange traded funds (ETFs), an investor’s capital is fully at risk and investors may not get back the amount originally invested.

Summary

Most investors will allocate a portion of their portfolio to gold. Given the wide variety of different ways to buy, own, store and sell gold which are now available, investors are becoming more discerning in their choices.

By being aware of the hidden risks in this safe haven asset class, investors can make informed choices about how they make their allocations. Physically backed ETCs are a very popular way to invest in gold as they provide a convenient low-cost and liquid access point, but there are important differences around cost, custodianship and sourcing that provide points of differentiation in this high growth market.

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