Why Gold ETFs Trump Gold Bullion

February 25, 2009 | By: Investment U

by Matt Weinschenk

I really don’t care for talk of gold investments. There are a small but dedicated group of “gold bugs” that seem to think gold is the only thing anyone should invest in. When someone starts blathering on about gold, I normally shut down pretty quickly – can you blame me?

But lately, gold is one of the leading topics in the investment world. The interesting thing is that it’s been acting counter to what most market watchers have expected.

First, gold didn’t rise as sharply as expected during the flight-to-safety after the markets collapsed. Then government spending raised fears of a legitimate currency collapse. Finally, gold did top out, just over $1,000 an ounce.

And today it’s continued turning around, falling almost 2% as of the time of this writing.

I’ll also mention the chatter caused by my colleague Louis Basenese to recommend that we should start shorting gold now. You can read more here about his Shorting Gold Call.

I’m sure some people do well trading the volatility and movement from gold. And there are many who hoard gold as the currency of “last resort” to prepare for an apocalyptic collapse of, well, pretty much everything…

But for most, it should simply be a specific percentage of your asset allocation, held as a hedge against inflation and uncertainty. It’s the smart way to get the most out of this asset – like any other in your portfolio.

So with all the activity and interest right now, I thought I’d share my favorite way to invest in gold.

Bullion is for Survivalists, Here’s a Better Option

Sinking your precious investment resources into “hard” currency like gold may work for some. But for the rest of us, we need something a bit more liquid. And while there are lots of ways to add this Midas metal to your portfolio, I like Market Vectors Gold Miners ETF (GDX) over anything else. Here’s why…

Instead of investing in actual gold bullion (or even worse, derivatives thereof), Market Vectors Gold Miners ETF invests in a basket of gold mining company stocks.

And believe me, this is a good thing.

The real return on gold is essentially (and by definition) zero. Jeremy Siegel’s database shows that $1 invested in gold in 1800 was worth $0.98 in 2000 when adjusted for inflation.

Research by William Bernstein, author of The Intelligent Asset Allocator and The Four Pillars of Wealth, shows that gold equities do significantly better. The annualized returns of his make-shift gold shares index were 12.81% from January 1969 to September 1996. That not only slaughters gold, but outpaced most other classes of stocks over the same period.

But if you look into it, the first thing you’ll notice is since the start of 2008, investment in a gold bullion fund, like SPDR Gold Shares (GLD), has far outpaced that of gold equities.

That’s mostly a symptom of a sharp decline in the P/E ratios on equities overall. However, I consider this a significant buying opportunity. When the stock markets do rebound, gold equities will outpace bullion by leaps and bounds.

Now, if you invest in gold to be sure that you can buy shotgun shells and canned food when the world economy collapses, you’d be better off with gold coins in your wall safe.

But if you’re looking to round out your diversification (and not make a particular long or short call on gold), now is the perfect time to utilize gold equities through Market Vectors Gold Miners ETF as a method of diversification that still provides exposure to precious metals.

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