By any account, bullion trackers have been a stunning success. Gold held by exchange-traded products has leapt from just over 10 million troy ounces at the end of 2005 to over 70 million ounces now.
Combine that with an increase in the gold price from around US$513 an ounce on the last trading day of 2005 to US$1,760 now, and you’re talking about a 25-fold jump in the overall “footprint” of gold ETPs in six years, from around US$5 billion to over US$125 billion.
The owners of these trackers have been pretty much the only players in the capital markets to have not only ridden out the upheavals of the last few years, but to have made healthy profits as well.
I’m in the camp of those who believe there’s more to come from gold’s bull market. A temporary setback may be in order given the meteoric rise this year and the recent flight into bullion as a result of equity market declines. But, given rising sovereign and financial sector default risk, it would seem foolish to bet against gold right now. And I don’t think we’ve yet seen the kind of mass-market, retail-driven mania that should typically mark the top of a multi-year uptrend.
But with success and with an increasingly crowded marketplace come the inevitable problems of growth.
The Financial Times reported this morning that the cost of vaulting gold has more than doubled this year at some of the major London-based bullion banks, reflecting capacity constraints. The huge jump in the gold holdings of ETFs and ETCs is cited as one of the main causes of the disappearing vault space.
According to Ben Traynor of Bullion Vault, the rise in custodians’ storage charges probably has more to do with rising insurance premiums than an actual shortage of physical space, since gold takes up so little room per unit of value. For silver, by contrast, says Traynor, the growth of investor interest is posing real problems for some custody networks.
The FT says that fees for storing gold range from 0.03 percent to 0.15 percent a year, depending on the size of a client’s holdings. Perhaps larger owners—the US-listed SPDR gold ETF, for example, which is not far short of becoming the world’s largest exchange-traded fund of any type, with over US$70 billion in assets—can still command storage rates at the bottom end of this range. HSBC, custodian for the fund, declined to comment on its pricing policy.
The four largest European gold trackers—ZKB’s gold ETF, ETF Securities’ physical gold ETC and Gold Bullion Securities and Julius Baer’s gold ETF—all charge at or close to 40 basis points each as annual management fees, the same as SPDR gold.
Given the continuing growth in the gold ETP market, the reported rise in storage costs may not be making a big impact on these issuers’ overall profits, even if their margins may be declining a bit.
But the cost increases may well threaten the business models of the issuers of gold trackers controlling smaller amounts of bullion. A 15 basis point annual charge for storage would eat up more than half the expense ratio of some recently issued products. iShares, for example, charges only 25 basis points, all-in, for its gold ETC, while Deutsche Bank levies 29 basis points a year for its version.
So if rising costs for gold ETPs are one sign of the market’s success, they may squeeze out some of the more marginal players. And given cost increases, the incentives for issuers to cut corners when managing custodial arrangements must also be on the rise. Investors should undoubtedly pay attention to the small print of prospectuses, particularly the sections relating to custody, insurance and the procedures for creating and redeeming ETP units.
We’ll be digging into some of these issues in more detail during our next webinar, to be held on September 6. I’ll be joined by Suki Cooper, precious metals analyst at Barclays Capital, and Charles Morris of HSBC Asset Management. Attendance is free—please sign up to listen in!