BOSTON (MarketWatch) � When the price of gold hit its lowest level in three months this week, nervous investors and gold supporters had vigorous arguments over whether it was a respite in the gold bull market or the end of it.
While people willing to bet heavily one way or the other argue that point, the one thing that can�t be argued is that the recent decline in gold prices � and the arguments over the future direction of its price � have made gold-futures exchange-traded funds like the PowerShares DB Gold Fund DGL the Stupid Investment of the Week.
Click to Play Gold is tumbling. Good time to buy?WSJ Heard on the Street columnist Liam Denning visits Mean Street to talk about the recent gold selloff.
Stupid Investment of the Week highlights the concerns and conditions that make a security less than ideal for the average investor, and is written in the hope that showcasing danger in one type of investment will make it easier to avoid trouble elsewhere.
In fact, many of the arguments against ETFs using gold futures could apply to any futures-oriented commodities fund.
While obviously not a purchase recommendation, this column is not intended as an automatic sells signal.
Futures-based gold investing can vary in a number of different ways, but the basic idea is to deliver returns by investing in futures contracts on a commodity, in this case gold.
Unlike trading individual futures, where an investor needs a futures account and which gets into ground that average investors typically avoid, buying an ETF is easy. A futures exchange-traded fund takes away the complexities of trading, and lets the investor get instant exposure to futures contracts on gold.
Indeed, that has made futures funds a staple of some newsletter editors� trading strategies, which puts them in the realm of ordinary investors.
That said, for the person wanting to hold gold � and there are plenty of good reasons to do that, even though the metal has declined in price roughly 15% since September � buying the metal itself through a fund like SPDR Gold Trust GLD �or iShares Gold Trust IAU �makes more sense than using a futures-based fund.
To see why that is, you need to understand a little bit about the futures market, and about a phenomenon called �contango.� Average investors probably should think of contango this way: If you don�t know what it is or how it could affect you, don�t buy any futures-based ETF.
Contango occurs when the next futures contracts are more expensive as time goes on, creating a loss of value when the ETF automatically sells the current contract and purchases the next one. In time, contango can kill a significant amount of value in a single investment.
For people used to common mutual funds, think of this as an additional expense burden, because it becomes a significant drag on returns over time. While some firms have taken steps to mitigate the effects of contango, there�s no denying that it makes futures-based funds more appropriate for traders than average investors.
Most commodities funds face contango, but it�s virtually unheard of for a gold-futures fund to not have it. There are some rare times when this futures roll-over process can work to an investor�s advantage when front month futures are cheaper, which actually adds value in the roll process between contracts.
This is known as backwardation, and Scott Burns, director of ETF research at Morningstar Inc. noted that is has happened for a few days in recent years, �but it�s really only likely to happen on super-panic days, and probably more for a few super-panic hours than even full days at a time.�
�When things are in contango, there is always negative roll yield, so the longer you hold it the more you lose to it,� said Burns, who favors funds that hold the metal for investors who want gold exposure.
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