The hidden risks of gold trading

All that glitters might be just what your portfolio needs now. The gold market is having its best run in many years. Prices have climbed by around 50 per cent since 2018, when the metal bottomed under Sh120,000 an ounce.

The yellow metal has also climbed by around Sh40,000 an ounce from March’s Covid-19 crash. As a result, gold Exchange Traded Funds (ETFs) are rising in popularity.

It’s easy to judge why; they’re easy to trade, there’s no need to store anything and no one is going to break into your house to steal your ETF.

However, gold ETFs and gold bullion are very different investments.

Today, we spotlight some of the risks associated with the Barclays NewGold ETF [the only listed ETF at the Nairobi Securities Exchange (NSE)].

To begin with, all NewGold bullion is held by the Custodian (ICBC Standard Bank) in its vaults in England.

But how safe are the fund’s holdings? Is the custodian bank trustworthy enough to safeguard the gold? Not entirely.

There is a risk that the gold bullion belonging to NewGold could be lost, stolen or damaged. In that event, NewGold may not be able to request either the sale or delivery of the bullion for itself or on behalf of any Qualifying Debenture Holder.

Besides, since the custodian is allowed to use sub-custodians, such as another bank, to source and store gold, there’s an additional risk. On top of the risk an investor assumes with the fund’s primary custodian, investors are exposed to even more risk because it has added another counterparty.

Is the NewGold fund protected by adequate insurance? Not easy to judge.

Although the main custodian is obliged to maintain insurance policy cover under the Custody Agreement, it’s possible, it may fail to maintain the required insurance. In fact, the value of the gold in the vaults is likely to be much greater than the insurance cover.

As a result, debenture holders may have to rely on NewGold having a claim against the custodian and NewGold recovering from the custodian.

Are the NewGold ETFs easily tradable? Not quite.

Although its expense ratio is equally competitive at 0.4 per cent (Sh4,000 for every Sh1,000,000 investment), its bid-ask spread is unattractive and makes trading expensive owing to infrequent trades in the counter.

This is the curse of being small and illiquid.

Lets take the iShares Gold Trust in comparison. It has an expense ratio of 0.25 per cent and trades frequently.

If you’re holding your gold ETF for a shorter period of time, such as a few months, then the spread is likely one of your main costs.

In summary, though owning gold ETFs are an excellent way to diversify a portfolio, investors ought to know that they come attached with risks.

In all, for discerning ones, it pays to understand that there are a lot of hidden dangers inherent in the structure and operation of gold ETFs that few investors are aware of.

Mwanyasi is managing director, Canaan Capital Ltd