I assume you know about the big drawback to commodities: They are insanely volatile. The other things to consider are the costs and taxes of owning them. I’ll focus on the latter two in reviewing five different ways to get your hands around hard assets.
Buy a gold ETF
The biggest and best known exchange traded fund holding commodities is the SPDR Gold Shares, ticker GLD. It has $56 billion worth of metal tucked away here and there. It trades a furious 15 million shares a day.
Cost to you: 0.4% a year. That is, you’re paying State Street Corp, the World Gold Council and the other middlemen not quite $6 a year to hold a troy ounce of metal and feed the guard dogs.
For in-and-out traders this fund can’t be beat. The bid/ask spread is often only a penny, negligible on a $140 stock.
Long-term holders would be better off in the much smaller ($5 billion) iShares gold fund operated by BlackRock, at an annual fee of only 0.25%. Ticker: IAU.
True worrywarts might find more reassurance in an ETF from ETF Securities, which makes a big fuss over where it stores its bullion: in Zurich, as opposed to the sketchier locales (like Toronto and London) used by competitors.
Most of the $25 billion of assets run by ETFS out of its headquarters on the isle of Jersey are in overseas securities. It has $3 billion in U.S. funds, including the $1.3 billion gold fund, ETFS Physical Swiss Gold Shares (ticker: SGOL). The cost of this product is 0.39% a year.
If you like silver, even more volatile than gold (and much hotter in 2010), the big fund is the one from iShares, with $12 billion of bullion. Ticker: SLV. Cost: 0.5% a year.
The folks from Jersey offer a discount. For now, ETFS Physical Silver Shares (SIVR) costs only 0.3% a year.
For Americans, the tax treatment of all these products is the same. Metals, and the funds that hold metals, are considered “collectibles.” Hold for more than 12 months and you pay a maximum 28% federal tax on gains.
Collectibles gains and losses blend on your tax return with gains and losses from other capital assets. If you have a $10,000 loss carryforward from stocks and take a $12,000 long gain in gold, your federal tax is $560.
What’s not to like about gold and silver? The volatility doesn’t bother me. I can stand volatility on something that might be 5% of my investment portfolio and which, moreover, is uncorrelated with those other assets.
I see a different problem. Technologic breakthroughs have lowered the cost of extracting natural gas from the ground, depressing the price of this commodity. The same could happen to gold. Surely the quadrupling of prices in the past decade has inspired prospectors and chemists to find new ways to get the metal.
I have been skeptical of gold for a while on this basis, and the market has proved me wrong so far. Bulls will tell you that gold will steam up to $3,000 before the decade is out. That could easily happen.
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Buy a commodity ETFThe big one is the PowerShares DB Commodity Index Tracking fund, with $6 billion in hand and 2 million shares a day of trading. The product represents a joint venture between distributors at Invesco’s PowerShares and traders at Deutsche Bank. Ticker: DBC.
The fund is weighted toward energy but also has precious metals, base metals and agricultural commodities. It’s expensive, at 0.85% of assets per year.
The fund owns futures, not ingots, oil barrels and sacks of grain. That makes its tax treatment different.
People who hold futures tally up their paper gains and losses every Dec. 31, recording them as if they were 60% long and 40% short, never mind how long they have been held.
With the rate on long gains 15% through the end of next year, and on short gains 35%, your blended rate is 23%. Under present law these component rates pop up in two years to a maximum of 25% and 44.6%. (I am including the effects of a health care surcharge and a deduction clawback.) That gives you a blended 32.8%.
The next tax bill might have some break for wealthy investors, lowering the 32.8% number, but it will surely leave in place the mark-to-market treatment. That’s a big negative for very long-term holders.
If you are planning to sit on your commodity hedges for 30 years in a taxable account, you are better off with a bullion ETF. Deferral of your tax bill is worth a lot.
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Buy a commodity ETNAn exchange traded note is a bank IOU with returns pegged to some index. In the case of the iPath DJ-UBS Commodity Index note, the bank is Barclays and the index is one covering a broad basket of metals, fuels and farm products. It’s less energy-intensive than the ETF from PowerShares.
Ticker: DJP. There are $3 billion worth of the notes outstanding, with 400,000 shares a day of activity. Expenses run 0.75% a year.
There is risk here, beyond the pricing of wheat and oil. Your piece of paper is a note from Barclays. If the bank goes under, you don’t get your money back.
Taxation: murky. For now, holders selling after 12 months get a 1099 from the broker reporting the sale as the sale of a capital asset eligible for favorable long-term capital gain rates. But the IRS, which has been silent on the matter, might surface with a contrary view.
The tax collectors could decree that any gains on ETNs are bank “interest,” taxable at steep ordinary-income rates. Some Wall Streeter would fight back. The discussion would then move to a courthouse.
My guess is that Congress will arrange some kind of compromise with a partial grandfathering for present investors. They’ll get the low rate on appreciation up to the point when the bill is enacted, provided they declare their paper profits right away. But it’s just a guess, and the tax treatment could ultimately be a whole lot worse than this.
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Trade futuresCould you buy direct and save? Instead of buying 1,000 shares of GLD, you set aside $140,000 of interest-bearing collateral and go long one 100-ounce gold future on Comex.
You’ll save the $6 an ounce that is the ETF’s annual holding fee. You’ll pick up a few dollars an ounce by investing the cash. But you’ll have to eat the contango.
Contango is the upward slope of futures prices over time. In effect, the cost of holding bullion is built into futures prices. Recently the October future was quoted at a $4 premium to the April future.
When the dust settles you will have saved little or nothing. But if you were planning to hold for less than a year the futures will save you a bit on taxes. They get that blended 23% rate, while short-term gains in collectibles are taxed at 35%.
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Amass gold coinsThese are fun to hold. But there are costs.
You’ll pay a premium over bullion value when you buy.
Then you’ve got the cost of a shotgun under your bed.
When you sell, the dealer will pay you less than the bullion value. That’s because he doesn’t know whether your bag of coins is in fact a bag of gold-plated tungsten slugs. He’ll incur risk and/or assaying costs.
A round trip in coins is going to cost you 10% or more, says Will Rhind, an executive at ETF Securities.
He may be overstating the problem, but still. That would be 100 times the transaction cost in ETFs.
I classify gold coins held as inflation hedge in the category “Highly Stupid.”
