You must own the right kind of Gold!
Dear reader,
In my letter to you on 25 May 2011 I told you why you can’t go without gold. Uncertainty in financial markets is the ruling emotion.
Inflation in debt-ridden countries like the United States will definitely push commodity prices higher.
And as if that’s not enough there will be an enormous growth in demand for gold from Asia.
China has already started getting rid of dollar reserves and replacing them with gold. India’s got an enormous population of a billion plus that will keep using gold as their primary vehicle of wealth and inflation protection.
All these factors set the perfect scene for a boom in the gold price. There’s so many ways to profit off this boom but what’s the best?
I received a comment from a reader, asking my opinion on the Newgold ETF and the security of investing in it. Specifically because it's issued by a bank and the banking industry is almost solely responsible for the financial crisis we’ve experienced.
To answer this reader's question I’d first like to show you the difference between an ETF and an ETN.
Differences between an ETF and an ETN
| Feature | ETN | ETF |
| Issuer | Standard Bank Gold Commodity linker ETN | Absa NewGold ETF |
| Liquidity | Market Maker | Market Maker |
| Recourse | Issuer Credit | Underlying Securities or assets |
| Principal risk | Market and Issuer credit risk | Market Risk |
| Tracking Error | No | Yes |
As you can see, I’ve provided a table comparing the Standard Bank Commodity linker ETN to Absa New Gold ETF.
Both of these instruments enable holders to profit from the gold boom but there are important differences which may leave unaware investors in a tight spot when trouble comes…
The risk you take when buying gold
Basically you’ll always expose yourself to market risk when buying any instrument exposing yourself to gold. The market risk is the risk you take to actually own the asset. It’s a risk we’re all aware of, the risk you take when buying a share or in this case an ETF or ETN.
But when you look at ETNs there’s another risk you’re exposed to.
The banks call it the "Issuer Credit Risk" and easily shrug it off as nothing when trying to sell their products to unsuspecting investors.
They say that credit risk is virtually zero, because who’s ever heard of a bank going bankrupt before?
Yeah right!
What the banks try to hide from you
So, you ask, why do ETNs pose this credit risk and ETFs not?
There’s an easy answer.
Basically an ETN is a credit note. The issuing bank promises you that they’ll pay you back your money when the credit note is redeemed. That means that if the bank defaults you are treated like a creditor and you stand a chance of not getting your money back.
When you compare that to the New Gold ETF for instance, you’ll know the ETF is backed by physical gold and is not exposed to the risk of the issuing bank defaulting. If Absa were to default New Gold would still exist.
If you compare that to the Standard Bank ETN, if Standard bank defaults the ETN will cease to exist and investors in it may lose some or all of their money!
Make sure you protect yourself when investing
So even though issuers of ETNs and ETFs have to comply with JSE listing rules, the rules for these instruments are different. ETNs leave you unprotected while ETFs are much safer.
Vladimir Nedeljkovic, the head of investments at Absa Capital, says “NewGold Issuer has been structured (as required by the JSE) to be insolvency remote (restricted activities, no debt allowed, and the only asset held is gold).
"In addition, qualified investors, namely those holding necessary permits and a sufficient quantity of NewGold ETFs, can exchange them for bullion.”
Not all gold is made equal!
Now considering that investing in GOLD is one method we use to secure, protect and grow our wealth it’s no use investing in instruments where you are lending money to the bank on the promise that it will provide you with a return equal to the value of the commodity (less costs).
Where no money is invested in actual gold and no one has a right to demand actual gold, and the debt is on the bank’s balance sheet.
It’s for this reason I prefer investing in Newgold ETF. I know that the fund is fully backed by physical gold and my money is safe irrespective of what happens to the bank that issued it.
Especially since banks are riddled with uncertainty and questionable balance sheets.
Here's to unleashing the value!
Francois Joubert
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