- AAAU is a unique ETP in the gold space in that it allows physical delivery while only charging a small 0.18% expense ratio.
- AAAU is guaranteed by the Government of Western Australia which is another unique feature of the product.
- As long as gold outperforms the S&P 500, holding the commodity makes for a strong play.
The last year has been fairly rewarding for shareholders of the Perth Mint Physical Gold ETF (AAAU) with overall returns entering into the 27% range.
In this article, I argue that shareholders of AAAU are likely going to see reward into the next year based on gold fundamentals. Not only is this the case, but AAAU’s unique setup allows investors additional optionality in their investments as compared to most other rival gold funds.
In the gold ETP space, AAAU remains one of the most unique products I’ve seen. The reason why I say this is that this ETF allows investors to directly redeem shares for physical bullion. Not only is this the case, but the Perth Mint is actually owned by the government of Western Australia which adds a degree of security to the issuance of the fund.
Delivery may seem like a fairly complicated process, but it is actually somewhat streamlined in that investors are able to enter a claim form directly on the ETF’s site and after a few delivery fees have gold directly shipped to them in exchange for shares. I believe it serves a very specific demographic: those who are investing in gold for the security of the investment rather than specific capital gains or losses.
Not only does AAAU allow physical delivery of gold, but it also gives exposure to the commodity at a very low expense ratio of 0.18%. Put simply, this is less than half as expensive as GLD, which is the king of gold ETFs at this time.
From a financial perspective, I personally do not see the appeal of physical gold ownership. My primary thinking when I study an instrument like AAAU is its risk, reward, and correlation with major gold benchmarks. As an active investor, I am looking for ETPs which directly line up with my views on gold markets and allow me to express them in cost-effective ways.
Seen in this light, I view AAAU as a solid investment in that similar to other gold ETFs, it marks its NAV to the LBMA price. This is important to me because the LBMA mark is widely used with a very rich history of prices. For example, in the next section I will show a backtest I’ve created to help predict where gold prices may travel which relies on over 50 years of LBMA history. Since AAAU is marked against this index, this means that this backtest is directly correlated with what AAAU investors would have earned during this time period (net the expense ratio of course).
Another reason why I favor AAAU as a gold ETP is the fact that it’s holding physical gold and not financial futures. The reason why it’s an advantage to hold physical gold is that you aren’t exposed to roll yield from the financial markets.
Roll yield is what you get when you hold a position on a futures curve and that position convergence towards the spot market. Since the futures market tends to be in contango for gold (due to borrowing costs and arbitrage economics), this means that gold is largely in contango almost all of the time (with futures contract priced above the spot market). As can be seen on this link, gold’s futures curve increases at a pace of about 2% per year which means that at today’s interest rates, futures holders are losing about 2% per year due to the futures contracts converging with spot. Since AAAU holds physical gold, it is removing this roll yield component.
While AAAU isn’t holding futures and therefore isn’t getting dinged from roll yield, this isn’t unique to this ETF – several other products hold physical gold. Where I believe AAAU shines for investors is the physical delivery option as well as the low expense ratio. If you want the option to receive your gold, then I believe that this is a strong ETP for you.
However, a potential concern here is that AAAU is somewhat more illiquid as compared to alternatives. For example, AAAU has a market cap of $498 million while its rival GLD has a market cap of around $77 billion. The implication here is that if you are going to be actively trading (more than once per month), then you likely will experience slippage or wide bid-ask spreads with AAAU which will likely add up to underperformance through time. For this reason, I believe that at this point, only longer-term holders (or those who want the option to accept physical delivery) should hold this product at this time.
Prior to giving a holistic recommendation on AAAU, we need to examine where the gold markets are likely going to travel. It makes no sense to hold gold in an environment in which prices are likely going to fall and in this section I present a backtest which I believe shows that gold is likely going to rise in the future.
At present, there’s an interesting relationship at work in financial markets which is actually somewhat rarer than one would think: gold is outperforming the S&P 500. This may seem like a no-brainer for those who have witnessed the last year of financial volatility, but from a backtesting perspective, when gold is outperforming the S&P 500, it tends to make for a fairly sound trade.
This chart shows the cumulative return an investor would have earned over the past 50 years if they had invested in gold only when gold was outperforming the S&P 500. How this strategy works is that an investor starts the month by comparing the past 1-year return in gold and the S&P 500. If the return of gold is stronger than the S&P 500’s return, you hold gold for another month and reassess. If gold’s performance lags the S&P 500, then investors exit their gold position.
This relatively simple strategy captures a key dynamic at work in gold trader psychology: the pursuit of gold when it is performing more strongly than other assets. I believe the data shows that investors tend to mainly only flock to gold when it has been performing well versus alternatives. This leads to streaks of outperformance in which gold prices shine versus alternatives and these streaks can last for several years at a time. For example, this trade delivered 150% of returns from 2000 through 2008.
To get an idea as per the performance of this strategy versus simply buying and holding gold, here’s a comparison:
- Buy and hold: 0.75% monthly return, 4.92% monthly standard deviation of returns
- Strategy: 1.55% monthly return, 3.49% monthly standard deviation of returns
Put simply, this strategy doubles the average monthly return of simply buying and holding gold while reducing the standard deviation of returns. In other words, if you were to simply employ this strategy in your AAAU holdings, history has shown that you would have significantly outperformed the buy and hold in terms of a risk-adjusted return.
AAAU is a unique ETP in the gold space in that it allows physical delivery while only charging a small 0.18% expense ratio. AAAU is guaranteed by the Government of Western Australia which is another unique feature of the product. As long as gold outperforms the S&P 500, holding the commodity makes for a strong play.
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