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Investing in Gold Index Funds

Why I Prefer the Goldminers Index (NYSE:GDX)

Written by Brian Hicks
Posted October 16, 2009


gold bars


It seems like everywhere I go these days, I'm bombarded with questions about investing in gold index funds.  And I can't say that I'm surprised by it—not by a long shot.

After all, considering all of the bad press the dollar has gotten lately, everyone is down on the greenback. Gold as a result has broken out to new highs.

And while I explained in this article last week why I'm not a big fan of physical gold, I do believe gold index funds are a much safer way to invest in the trend.

First though you need to understand how exchange-traded (ETF) and index funds function.

Developed in the 1990's, exchange-traded funds are in many ways the best of both worlds. That's because they combine they ability to make a broad sector bet as you would in a mutual fund, with an instrument that performs on a day-to-day basis much more like an individual stock.

Let me explain.

In short, what an ETF represents is a security that tracks an index, a commodity, or a basket of assets. That makes them quite similar to what you would find in any mutual fund.

However, what makes ETF's different, and in some cases more effective than mutual funds is that they can be bought and sold throughout the day just like stocks on an exchange.

As such, these exchange traded funds allow individual investors the ease and safety of diversification while still allowing for all of the ordinary features of an equity, such as limit orders, short selling, and options.

Moreover, unlike shares of a mutual fund, whose price can only be determined by its Net Asset Value (NAV) at the close of the day, the value of a share in an ETF can go far beyond its underlying value as investors bid up the shares.

Smart traders, of course, love this fact and use it to their advantage as the make their broad sector bets.

So while mutual funds are relatively passive investments whose true worth is based solely on the actual share price of the stocks owned by the fund, an ETF investor needs to be more active in managing those shares.

Of course, keep in mind that those same laws of supply and demand that govern the price of an ETF, can also work in reverse. ETF's can and do trade below their NAV.

That's why investors in these funds need to keep a very close eye them. Passive mutual funds they are not. That perhaps is the single most misunderstood aspect of these funds.

Nonetheless, ETF's do offer other advantages beyond mutual funds. They include:

  • Lower Fees: ETFs are no-load funds. That means that you won't be slapped with a redemption fee when you decide to close your position. Moreover, ETFs typically have lower annual fees than traditional Mutual Funds.
  • Liquidity: The exchange-traded structure of ETF gives them much greater liquidity in the markets. That allows ETF investors to close their positions much faster than a mutual fund, which must be liquidated at end of day.
  • No Minimum Investment: Diversification can be tough for new investors-especially if you're using a mutual fund. That's because traditional mutual funds frequently have a minimum investment of $2,500 or more. ETF's, on the other hand, carry no minimums making for easier asset allocation.

As for a gold index fund, I prefer the miners in this case since they likely have more upside at this point. 

My favorite is the Market Vectors Gold Miners ETF (NYSE:GDX).

It's a fund whose top ten holdings include: Agnico Eagle Mines (AEM), Anglogold Ashanti (AU), Barrick Gold (ABX), Gold Fields (GFI), Goldcorp (GG), IAMGOLD Corp. (IAG), Kindross Gold (KCG), Lihir Gold (LIHR), Newmont Mining (NEM) and Yahmana Gold (AUY).

Buying the GDX gets every investor a piece of each one them. What's more the fund is highly liquid trading an average of almost 9 million shares a day.

Related Articles:

Getting Ready for the Golden Years

Why Gold Is Due for a "Spectacular" Rally

How To Invest in Gold in 2009


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