Are gold ETFs worth their weight?

There are plenty of reasons why investors turn to gold in times of turmoil and solid arguments for doing so. The recent rally, which follows several years of poor performance, is being driven by rising fears over a recession and the hunt for insurance assets, which behave differently to the rest of the market. Gold is typically uncorrelated to currencies, equities and bonds and, as such, is seen as a safe haven.

Gold trader Bullion Vault says: "Gold isn't debt, it isn't equity and it certainly isn't cash on deposit. Nor is it particularly useful to industry. In a world glutted with debt, equities, bank deposits and industrial commodities, that makes gold suddenly very useful to money managers and private investors needing something to do what gold has always been used for - storing value when other things fail."

In the year to date, sterling-based physical exchange-traded commodities (ETCs) have surged, with the majority returning more than 20 per cent, compared with a fall of 1.5 per cent by the FTSE 100 and a fall of 0.9 per cent by the FTSE All-Share.

Christopher Mellor, director of equities product management at Source, says: "ETFs are a great barometer of market sentiment. Given the challenging start to 2016 and nervousness in the markets, there is clearly a renaissance in gold as a haven."

Fools gold?

But gold is not a haven, nor necessarily a store of value. There is a difference between a defensive, uncorrelated asset and the concept of a safe haven, which offers protection in all conditions. Gold is a highly volatile asset that can suffer sharp price corrections. In 2013, for example, while the FTSE 100 rose by 18.7 per cent, sterling-based gold ETCs lost around a third of their value, an amount they have struggled to make back since. That is because while gold outperforms in falling markets, it suffers when interest rates rise and better returns can be had elsewhere - gold, after all, is a zero-yielding asset.

"We are now seeing the first uptick in gold in a very long time," says Adam Laird, passive investment manager at Hargreaves Lansdown. "The fact gold recently fell by a third really calls into question its status as a safe haven asset. Calling it a safe haven gives the impression that gold is an alternative to cash, which it really is not. Gold can add benefit as a small diversification in a portfolio, perhaps 5 per cent, but I don't think investors should be rushing into it for security as it is volatile and we could see it fall again."

Compared with other assets, including low-risk bonds or cash, gold pays no interest and if rates rise in the medium term it will become far less appealing.

Gold for the wise

But that is not to say that there is no use for gold in a portfolio. It is still a good asset for defensive diversification.

"Gold has no intrinsic value - most is derived extrinsically from other factors," says Ben Seager-Scott, director of investment strategy at Tilney Bestinvest. "But we do hold it at the moment because excess liquidity driven by quantitative easing has pushed up prices across the board, and we are seeing high correlations between bonds and equities. Therefore we are on the lookout for correlation assets and something that is perceived by investors to be a store of wealth - even if it has no intrinsic value."

Which ETC?

The most important thing when it comes to choosing a gold ETC is to opt for a physical product backed by gold bullion, rather than a synthetic ETC which works by buying gold futures contracts that track the future price of gold.

While physical ETCs give you exposure to the spot price of gold, synthetic ETCs are subject to volatile swings in the future price of the metal and bring with them the potential problem of contango - when the future price of the metal continues to be higher than the spot price.

Mr Seager-Scott likes ETFS Physical Gold (PHGP), which he says is "one of the largest and best known, and both low-cost and liquid".

Source Physical Gold P-ETC (SGLP) is also large and low-cost, with an ongoing charge of just 0.29 per cent.

Performance of gold ETCs (% total return and % cumulative return)

Source: FE Analytics, as at 5.03.16