Saturday, June 18, 2011

Gold ETFs and Derivatives

This article appeared in The Edge, Malaysia, May 23, 2011

Gold ETFs and Derivatives

In the midst of the craze of investors wanting to gain exposure to gold, various instruments have been introduced in the market. One of the popular ones is the gold exchange traded fund (“ETFs”). This article will first explain the mechanics of an ETF and then introduce the Exchange Traded Note (ETN) which is often thought to be similar to an ETF but is actually is different in many ways, mainly because of the use of derivatives in the latter.

What is an ETF
An ETF is basically a share that trades on the stock exchange. A company share represents the assets and liabilities of the company. An ETF share represents assets that could be almost anything - shares of companies, bonds, commodities or currencies. The main attraction of ETFs to investors is that it allows them to gain exposure to a variety of assets with minimum capital.

Gold ETFs
A gold ETF will purchase a large amount of gold, maintaining the physical metal in storage. The ETF fund manager will then issue ETF units to market intermediaries or brokers (called Authorised Participants) who are usually investment banks. The intermediaries will trade the ETF units which are now broken down into smaller units called ETF shares with the investor. Refer Chart 1.