Precious Metals ETFs: What They Are and How They Work

What Are Precious Metals ETFs?

Precious metals exchange-traded funds (ETFs) hold assets like gold, silver, and platinum and sell shares in their portfolios. Those who invest in a precious metals ETF are exposed to the price changes of these metals without having to own and physically hold them.

Investors typically have several reasons for putting a part of their portfolio into precious metals ETFs. Gold and its counterparts can provide a hedge against inflation and economic uncertainty, and their low correlation with assets like stocks and bonds makes precious metals ETFs a means of further diversifying a portfolio. They are also relatively convenient and liquid, especially compared with transporting, securing, and holding the metals yourself.

However, like other investments, precious metals ETFs have risks: They fluctuate with often-volatile metals prices, and the funds may not accurately track the performance of their assets.

How Precious Metals ETFs Work

Let’s review what’s similar about all ETFs, including those involved in precious metals, before going into the specific differences encountered by precious metals ETF investors. Like other ETFs, these funds are pools of capital that hold assets and trade on the major stock exchanges.

Here’s a breakdown of the roles:

• The sponsor: This firm devises, promotes, and manages the ETF. However, the sponsor doesn’t create ETF shares.
• Market makers: Companies that work with the ETF sponsor and the stock exchange on which it’ll be sold to ensure a consistent supply and demand of the ETF’s shares. They have set rules for trading spreads and the minimum amount of investment they’ll give prices for. They essentially guarantee that there’s liquidity for each ETF’s shares.
• Authorized participants: All ETFs have creation and redemption processes involving large financial firms—traditionally major banks like Bank of America or JPMorgan Chase & Co. The authorized participants create ETF shares by buying the underlying asset and exchanging it for shares in the fund. Authorized participants can then sell these shares to investors on the market. Conversely, authorized participants can buy ETF shares from investors and redeem them for the underlying assets (redemption). Only authorized participants—and not regular investors—can create or redeem shares by depositing or withdrawing the precious metal or other assets related to these commodities. The price of the shares is then determined by the net asset value (NAV) of the metals and other assets divided by the number of shares to be sold. The assignment of these firms is to ensure that shares in the ETF mirror the assets they are tracking.

While ETFs typically track the performance of an index of stocks or bonds, precious metals ETFs come in two broad categories:

Precious Metal Commodity ETFs

These follow the prices of precious metals like gold, silver, platinum, and palladium, either through direct holdings or through derivatives contracts. For ETFs that hold physical assets, authorized participants physically deliver bullion to the fund’s vaults.

Also, some precious metal commodity ETFs, instead of holding the metals, use futures contracts to track the price of the metal. In these cases, the creation and redemption process involves delivering or receiving the right number of futures contracts instead of the metals. Whether holding the precious metals in vaults, using derivatives contracts, or a combination of both, these funds look to mirror the performance of their underlying metal(s) in the market. Thus, for example, a silver ETF should gain 1% when there’s a 1% increase in silver prices.

Precious Metal Mining ETFs

These track the value of the companies in this sector that extract, refine, and trade these metals. The funds do this by holding a portfolio of publicly traded precious metal mining and related companies. The firms explore for these metals, mine them, process them, and then sell them on the world’s markets.

While the value of these businesses goes up and down with the metals they work with, owning shares in them through the ETF provides the benefit of this volatility not being tied one-to-one for every slight shift in these metals’ prices.

Nevertheless, precious metal mining ETFs face operational risks, labor shortages and strikes, and the explorational uncertainty involved in any mining operations. Many operations, like the metals themselves, are in areas affected by political struggles, climate-related disasters, and other contingent events that will influence the price of the metals and the companies that extract and refine them.

Benefits of Investing in Precious Metals ETFs

Precious metals investments can add diversification and hedge against inflation or economic turmoil. Investing in an ETF can give you access to the precious metals markets without the cumbersome and expensive process of receiving and storing the physical metals. Since you can buy and sell precious metals ETFs as easily as any stock, you can trade them from your regular brokerage account or even a tax-advantaged individual retirement account (IRA).

Thus, these ETFs are cost-effective for diversifying your portfolio with precious metals. If you buy gold or silver bullion, you might rack up significant fees and costs: storage, transportation, insurance, security, and so forth. However, trading precious metals ETFs is generally commission-free if you have an online brokerage account.

Precious metals ETFs also offer the advantage of their liquidity. While selling a physical metal asset would involve lining up a buyer, transporting goods, and so on, investors can easily trade ETF shares at prevailing prices anytime the markets are open. Being able to issue different order types, like stop-losses and limits, produces more flexibility in managing precious metal assets.

Risks and Limitations of Precious Metals ETFs

Like any other investment, precious metals ETFs have risks and challenges. First, the prices of precious metals and the funds that track them can be quite volatile, as they respond to economic and market conditions. The relative strength of the dollar, mining and production issues, industrial and central bank demand, and geopolitical events all affect the precious metals markets, so investors in these ETFs should be prepared for price fluctuations.

Precious metals ETFs also involve counterparty risk. If the fund’s management or the institutions backing the ETF face instability or financial issues, it could have an impact on your investment value and potential returns. This makes it particularly important to carry out due diligence before investing in any ETFs.

Types of Precious Metals ETFs

There are over 20 U.S.-traded precious metals ETFs, including a pair of exchange-traded notes (ETNs). We can separate these ETFs based on the precious metals or sectors in which they invest.

Gold ETFs

Gold has captivated human civilizations for thousands of years. The yellow metal retains its luster as a hedge against inflation and a store of value through volatile market periods. More ETFs invest in gold than any other precious metal, with some funds holding physical gold and others using derivatives to track gold prices. Gold mining ETFs invest in firms in the sector that explore, mine, refine, and trade this metal.

Gold is mined in far more places than other precious metals, including Australia, Canada, China, Kazakhstan, Mexico, Russia, and the United States. Almost half of all gold is formed into jewelry, with another 20% ending up in central banks.

Silver ETFs

Silver has its own storied history as a valued substance—during various decades of economic history, it outpaced gold as an international store of value. Its highly conductive properties make the metal useful for an array of industrial applications.

Silver, like gold ETFs, came onto the market in the early 2000s, seeking to replicate the returns of the silver market. These ETFs do so by holding physical silver bullion or using derivative instruments such as futures contracts linked to the silver price.

The supply of silver comes mainly from Australia, Bolivia, Chile, China, Mexico, Peru, Poland, Russia, and the U.S. A plurality of the silver, about 34%, goes into physical investments (bars), with another 27% finding their way into electronics.

Platinum and Palladium ETFs

Platinum is another precious metal with industrial uses, which is stronger and rarer than gold. There are two dedicated ETFs trading in the U.S. that provide exposure to platinum, both of which are backed by physical holdings. Each share represents a certain quantity of platinum stored in a secure vault, with the ETF trustee overseeing its management.

Palladium is used in industrial, electronics, and manufacturing processes. There is one U.S.-traded ETF offering exposure to the metal. Like platinum, it is also physically backed by palladium holdings.

Investing in these ETFs carries inherent risks, mainly market volatility. Platinum and palladium prices fluctuate significantly, often more than gold or silver, leading to potential losses and the stress that goes with it. Investors must consider supply-demand changes of these metals since they’re quite sensitive to market changes.

Platinum and palladium are platinum group metals, and the price of platinum is significantly influenced by its use in the automotive sector. When automobile sales are up, the value of platinum goes up. Essentially, when palladium prices increase, industrial manufacturers might switch to platinum, which, though usually more costly, is more efficient for specific uses.

Platinum and palladium are extracted from ore deposits, often alongside nickel and copper ores. The main sources for both are in South Africa, followed by Zimbabwe and Russia. They mainly find their way into automotive catalytic converters to reduce dangerous emissions that cars otherwise put out. They can also be found in bulk chemical production as catalysts, dental and medical devices, and computer hard disks.

ETFs That Invest in Multiple Precious Metals

Several ETFs offer exposure to several precious metals at once. These funds may physically hold various metals or depend on futures contracts to track their prices.

What to Consider When Investing in Precious Metals ETFs

If you are thinking about investing in precious metals ETFs, there are a few things to keep in mind. While you can trade precious metals ETFs with little or no commission, the funds have fees.

You should compare the ETF’s expense ratios, the amount charged to shareholders to cover the fund’s operating costs, which is given as a percentage of assets under management (AUM). Precious metals ETFs can vary widely in this regard, from as low as 0.1% to 0.9%. The expense ratio highly influences your net returns over time.

You’ll also want to review the liquidity of the precious metals ETFs you’re considering. Average daily trading volume can indicate how easy it is to enter and exit your positions. This is particularly crucial in this space since trading volumes can, for some ETFs, go down to a trickle.

In addition to their performance over time, you’ll want to compare precious metals ETFs for their tracking error, which occurs when the fund’s performance does not entirely match the changes in price for the underlying assets. It’s important to know a fund’s aims, including whether it’s backed by physical assets or derivatives, and the investment strategy it follows to track the performance of the underlying assets.

Top Precious Metals ETFs

The roster of U.S.-traded precious metals ETFs includes single-metal funds devoted to silver or gold, a few targeting platinum or palladium, and several ETFs that offer multimetal exposure. Here are some of the top precious metals ETFs available in the U.S.:

• SPDR Gold Shares (GLD): State Street launched the first U.S. gold-based ETF in 2004. GLD remains the largest precious metals ETF, with AUM of over $55 billion. The fund is backed by physical gold held in London and the vaults of sub-custodians. Holding physical gold might make GLD less susceptible to some uncertainties associated with derivatives-based strategies.
• iShares Gold Trust (IAU): iShares was not far behind in launching its gold ETF in 2005. It also uses physical gold holdings stored in vaults to track gold prices. With AUM of around $25 billion, IAU stands out based on its comparatively low expense ratio compared with GLD and other physically backed funds.
• abrdn Physical Platinum Shares ETF (PPLT): With over $900 million in AUM, the largest platinum ETF is backed by physical metal holdings. Given platinum’s high correlation with car manufacturing and other cyclical industries, you should only integrate this fund into your portfolio as part of a well-diversified strategy.

Taxes for Precious Metals ETFs

While trading precious metals ETFs is the same as any other stock or ETF, there are a few tax implications specific to this space.

Like other investments, your tax liability will depend on how long you hold the investment. If you own shares in a precious metals ETF for less than a year, you’ll trigger a short-term capital gains tax, which is levied at your regular income tax rate. If you hold the asset for longer than a year, you will owe taxes based on the long-term capital gains rate.

Precious metals are considered collectibles for tax purposes, and accountants typically agree that metals-backed ETFs fall into the same category. This means that precious metals ETFs are subject to a maximum federal long-term capital gains tax rate of 28%, higher than the 20% cap for stocks, bonds, and other investments. This higher tax rate can have an impact on your investment returns, so it should be a part of your calculation as you consider these investment funds.

Precious Metals ETFs vs. Other Precious Metals Investments

ETFs are a cost-effective way to gain access to the precious metals markets, helping you avoid costs like storage and delivery fees that you would face if you bought the physical metals.

Besides ETFs, mutual funds focused on the sector can provide exposure to gold, silver, and other precious metals. Precious metals ETFs stand out from their mutual fund counterparts because investors can buy and sell ETFs throughout the trading day, while mutual funds are priced and tradable after the market closes for the day. This allows traders to use ETFs to benefit from short-term, intraday fluctuations in precious metals prices. In addition, ETFs often have lower expenses and lower minimum investments than mutual funds.

Another way to invest in precious metals is to buy shares of mining companies—whether you load up on individual stocks or buy shares in a fund that invests in a basket of mining companies. Investing in mining stocks means taking an equity stake in the industry rather than gaining exposure to the metals’ price. Compared with precious metals ETFs, investing in mining companies involves other risks, including operational, labor, and geological concerns.

How to Buy and Sell Precious Metals ETFs

Buying and selling precious metals ETFs is a relatively straightforward process. Here’s a step-by-step breakdown that will have you investing in these markets:

1. Open a brokerage account: You’ll need a brokerage account to trade ETFs. When shopping around for a brokerage, it’s important to think about the guidance or other services you’ll want. Options range from do-it-yourself online brokers with low- or zero-trading commissions to robo-advisors to accounts with full-service financial advisors who work closely with you on your investment strategy.
2. Place trades: Once you’ve opened a brokerage account and moved funds into it, you can place orders for precious metals ETFs. Remember that you can place different types of orders with your brokerage, giving you control over the price you’re willing to pay or receive for each asset.
3. Reviewing performance: After you’ve put shares of ETFs and other assets in your brokerage account, you’ll want to keep an eye on the price performance of your investments. While it’s best not to panic over the ups and downs of the market, keeping track of your investments can help you develop, along with the advice of educational tools and finance professionals, your strategy for maximizing gains and minimizing losses.

The Bottom Line

Investors who want access to the precious metals markets without the arduous process of owning, transporting, and securing them in physical form often turn to ETFs. These funds can add diversification to an investment portfolio. Since they trade shares on the stock market, they offer liquidity and flexibility not available with other types of precious metals investments.

As with any investment, it’s important to understand how precious metals ETFs work, including their expenses and investment strategy. It may be worth talking with a financial advisor to help determine how these assets would support your overall investment strategy.