Claymore’s CGL: When Buying Gold Isn’t Enough

In Monday’s post, I answered a reader’s question about the iShares Gold Trust, an ETF that is cross-listed on the Toronto and New York Stock Exchanges with the ticker symbols IGT and IAU, respectively. I explained that while it is possible to buy and sell this product in either US or Canadian dollars, neither version gives you any exposure to currency risk. However, that’s not the case with the Claymore Gold Bullion ETF (CGL), which also tracks the price of the yellow metal by holding gold bullion. CGL is unique among gold ETFs in that it uses currency hedging.

It’s worth pausing to think about this concept. As most index investors know, it’s common for funds that hold foreign stocks or bonds to hedge their currency exposure to protect Canadians from the effects of a rising loonie. But gold is not a foreign-denominated asset, like shares in Coca-Cola. Yes, its price is widely quoted in US dollars, but that’s not the same thing. Think about it this way: if you were buying gold bullion from the Royal Canadian Mint, would it have occurred to you to hedge your purchase against a falling US dollar?

An extra layer of risk

So what’s going on with CGL? Claymore has designed its ETF to deliver to Canadian investors the returns of gold in US dollars. In practice, CGL’s returns should be the same for Canadians as the returns of the iShares Gold Trust (IAU) are for Americans. Since it launched in February 2010, it has done a very good job in this respect:

What investors need to understand is that CGL not only gives them exposure to gold, but also to the US dollar. If the greenback loses value versus the loonie, then a Canadian holding CGL would get a boost in returns. Indeed, since its debut early last year, CGL has dramatically outperformed the TSX-listed version of the iShares Gold Trust: it has increased over 43%, versus 30% for IGT. However, a surging US dollar will detract from the returns of the Claymore ETF, regardless of the price of gold.

While hedging is usually designed to reduce currency risk, CGL actually adds a layer of risk that wouldn’t otherwise exist. Buying IGT or IAU (or coins or bullion) makes you long gold. Buying CGL makes you long gold and short the US dollar.

If this discussion sounds familiar, it’s because the same strategy is used in the Claymore Broad Emerging Markets ETF (CWO), which I wrote about in a previous post. CWO invests in stocks that are denominated in a basket of overseas currencies, but adds hedging against the US dollar.

Doubling down

Using currency hedging in a gold ETF is an interesting strategy, because historically the US dollar and gold have been negatively correlated: when one goes down, the other tends to go up. So for a Canadian holding CGL, a declining US dollar could be doubly good: it would likely correspond with a rise in the price of gold, and the hedging would mean even higher returns in Canadian-dollar terms. If the US dollar were to surge, then CGL might suffer losses on both the gold and the currency.

One would think this relationship would make the price of gold in Canadian dollars more volatile. However, the Fact Card for CGL quotes data from 1994 that shows the standard deviation of gold returns is actually slightly lower in Canadian dollars (14.69%) than in US dollars (15.15%). Whether that would hold up over longer periods, I don’t know.

What I do know is that investors who decide to buy a gold ETF need to understand the role it plays in their portfolio. I think it’s fair to say that most retail investors who own CGL do not understand the currency exposure they are getting. They are likely unaware that they are not just buying gold, but also making an active bet that the US dollar will fall. Hating the US dollar is a popular pastime these days, but it’s a hard decision to justify in a long-term portfolio.

For investors who prefer to get pure exposure to gold and leave the currency plays to the speculators, Claymore launched an unhedged version of its gold ETF (CGL.C) in March. It should be expected to perform in line with IGT, although at 0.50% its management fee is double what iShares charges.

Disclosure: I do not CGL, IGT or any other gold ETF in my own portfolio.

21 Responses to Claymore’s CGL: When Buying Gold Isn’t Enough

  1. john July 28, 2011 at 8:35 am #

    I’d like to hear your views on the Central Fund of Canada (CEF), which, if I understand correctly, is a closed-end mutual fund that holds both gold and silver bullion. It is listed in Toronto and New York, so I assume it should perform similar to IGT, excepting of course the important difference that CEF’s silver holdings would engender. One sees frequent mention of CEF in U.S. media but it seems to get little mention in Canada.

  2. Canadian Couch Potato July 28, 2011 at 9:35 am #

    @John: I don’t know much about CEF, but a look at their portfolio holdings reveals that the fund is actually more than half silver: http://www.centralfund.com/Nav%20Form.htm

    That explains why it has dramatically outperformed gold ETFs recently.

    While I don’t think gold is a core asset class, I accept the logic of including, say, a 10% allocation in a portfolio, because gold usually does provide protection during crises. The same does not apply to silver, however, which plays no role in the monetary system. From the point of view of portfolio design and diversification, I would argue that sticking to gold makes more sense.

  3. The Wealthy Canadian July 28, 2011 at 12:29 pm #

    A very interesting read.

    I have been gobbling up as much information about ETFs as I can as I have just recently began investing in some within my portfolio. More often than not, I prefer to buy equities directly but when it comes to agricultural plays and gold, my preference would be owning actual land and bullion.

    To date, I have zero exposure to gold (either physical gold, equities, funds, etc) but will be looking to allocate perhaps a few percentage points of my net worth to gold sooner than later.

    I am in the process of purchasing roughly 95 acres of farmland, and I prefer owning land first than say positions in Agrium or Potash. I will want to own some of these stocks in time, but my preference is the tangible/physical land.

    The same would apply to me with respect to gold. With that being said however, I do like your feature on Calymore’s CGL. I like the idea how this ETF holds gold bullion and you can choose to buy the ETF in either currency. My only concern is that if the U.S. is able to put a band-aid on their current debt ceiling issues and we begin seeing some ‘recovery-type’ growth possibilities, we could see gold prices plummet with a rising U.S. dollar and this could hurt this ETF’s performance -if I’m not mistaken. What are your thoughts?

    I could be off, but that’s how I see things possibly happening. My problem with gold, is that I have a hard time making an educated thought process of where it’s heading. I can’t even tell you if I’m entirely long on it or not. I just feel that it will be important for me to have some exposure to it, as you say, in the advent of some cataclysmic event or market crisis.

    Nice post.

  4. The Wealthy Canadian July 28, 2011 at 12:33 pm #

    Ooops…I forgot to mention. I do have a small position in the Horizons Gold Bear. I could be way off, but my thought process behind the decision to buy last week is that I think we will see gold go down as the U.S. recovers (if it does). I’m currently up $64.oo on the investment so far.

  5. Jim July 28, 2011 at 1:31 pm #

    Thanks for another great blog entry.

    I have added IGT to my portfolio ( 4.3% of my portfolio). Your posts really helped me choose which ETF to use.

    I think I have built a very diversified portfolio of ETF’s. using the great information your web site provides, along with the writings of John Bogle, Larry Swedroe and David Swensen. As well, I am using the additional small cap and value ideas from the research of Fama/French.

    I found the two books I have read by Harry Browne and his Permanent Portfolio idea very interesting. He was trying to build what he considered a diversified portfolio, but it falls short in light of the research of recent years. I felt he was on to something, but his 25% cash and 25% gold were too extreme for me. But it did make me think that gold should have a small place in my holdings.

    Larry Swedroe mentions that a small addition of commodities to a portfolio will not increase returns but can make a portfolio less volatile over time. So I decided to add a small position of gold using IGF, to my holdings. I figure it incorporates a bit of Harry Browne’s ideas into my portfolio, while adding an asset that is not always moving in the same direction as the stock markets.

    As a result, I think I now have a portfolio that I can stick with and be confident in, as I re-balance it as needed.

    I am using my age to determine my Bond/Fixed income allocation (48%). leaving 52% in my equity type investments.

    The fixed income part of my portfolio consists of some laddered GIC’s and the rest split equally into XRB and XCB. David Swensen advises holding some real return / inflation protected bonds, hence the XRB. I also note that when the stock markets tanked in 2008, XRB went the other way, so it could help smooth out bad stock market years.

    The 52% of my equity holding breaks down like this:

    Canada 13.00
    US 13.00
    EAFE 8.67
    Emerging Markets 4.33
    REITS 8.67
    Gold 4.33

    Using these ETF’s:

    Canada
    4.33 XIU S&P/TSX 60 Index.
    4.33 CRQ Claym Cdn Fundamental E..
    I know there is overlap between these large cap ETF’s, but that is okay with me. The market is so small, it is hard to avoid.
    4.33 XCS S&P/TSX SmallCap.

    United States
    4.33 XSP S&P 500 Index (CAD-Hedged)
    4.33 CLU.C Claym US C$ non-hedged E.
    – CLU.C is my small bet that the CDN $ will fall against the US $ in the future – I think I have the logic of this right
    4.33 XSU Russell 2000 Idx (CAD-Hgd)

    EAFE
    4.33 XIN MSCI EAFE Index (CAD-Hgd)
    4.33 CIE Claym Intl Fundamental E.

    Emerging Markets
    4.33 XEM MSCI Emerging Markets Index Fund

    REITS
    4.33 XRE S&P/TSX Capped R.
    4.33 CGR Glb Real Estate E..

    Gold
    4.33 IGT-T Gold E.T.F.

    I know it is not perfect, but I don’t want to buy ETF’s that are in US dollars. I am hoping that when Vanguard hits Canada, they will offer some ETF’s that will allow me to fine tune this a bit more.

    Jim

  6. The Wealthy Canadian July 28, 2011 at 6:45 pm #

    @Jim

    Nice! I find your equity breakdown to be interesting and well diversified.

    TWC

  7. Canadian Couch Potato July 29, 2011 at 10:40 am #

    @Wealthy Canadian: Thanks for stopping by. I have no view on where the price of gold is headed. My only interest is whether gold plays a role in a long-term portfolio. I think it can, but if I did include an allocation to gold I don’t understand the logic of also adding a currency play on top of it.

    @Jim: Glad you found these posts helpful. Your portfolio is extremely well diversified. The challenge will be to manage all those moving parts over the long term. My suggestions would be to rebalance it only every two years, or only when you’re adding new money. Trying to keep 12 ETFs in balance more often that that will be expensive and may drive you crazy. Best of luck with your investing.

  8. The Wealthy Canadian July 29, 2011 at 11:17 am #

    I hear you. Adding a currency play on top of it is a bit of a heavy play if you ask me.

  9. Goldfinger October 11, 2011 at 8:56 pm #

    How can you say that CGL is adding currency risk.

    If you live in Canada, and you buy gold denominated in USD, then you are exposing yourself to currency risk. CGL is removing that risk.

    If you buy IAU (USD) and then gold stays flat (as traded worldwide in USD) and you go to sell your shares of the ETF, you will *NOT* be flat. You will have been exposed to the USD currency risk.

    If the currency went against you in that time then you lost money. This might surprise someone not thinking about the currency exposure.

    If you bought IGT (CAD) you will have seen that loss built into your share price.

    If you bought CGL (CAD and hedged) then you will be flat.

  10. Canadian Couch Potato October 11, 2011 at 9:11 pm #

    @Goldfinger: “If you live in Canada, and you buy gold denominated in USD, then you are exposing yourself to currency risk.” No, you’re not. This is a common misunderstanding. I explain why this is not true in this post:
    http://canadiancouchpotato.com/2011/07/25/ask-the-spud-ishares-gold-trust/

    Gold is not “denominated” in US dollars or any other currency. It is commonly priced in US dollars, but that’s not the same thing. Remember that gold ETFs hold actually bullion, and one ounce of gold owned by a Canadian investor will always have the same value whether he bought it in US or Canadian dollars.

  11. Rob October 31, 2012 at 11:01 pm #

    You state that the CGL C management Fee (0.50%) is double the IGT management fee. Is that true?

    I thought the CGL MER is 0.5% and the IGT MER was 0.4%?

    Where can I verify the MER for the IGT ETF traded on the TSX?

  12. Canadian Couch Potato November 1, 2012 at 7:55 am #

    @Rob: IGT is simply a Canadian-listed version of IAU, which has an annual fee of 0.25% as stated on its web page:
    http://us.ishares.com/product_info/fund/overview/IAU.htm

    TD Waterhouse also lists this fee on its page for IGT:
    https://research.tdwaterhouse.ca/research/public/ETFsProfile/Summary/ca/IGT

    Several iShares Canada ETFs hold US-listed products and then add an additional fee, but IGT is not structured the same way: it is not a Canadian-domiciled product, even though it is listed on the TSX. I have seen other sites mention that 0.40% figure (including the Globe and Mail) but I have not found a source for that claim.

    If you’re thinking about investing in IGT, I would suggest emailing iShares and asking them to verify.

  13. Rob November 1, 2012 at 6:20 pm #

    Thanks for the reply. I did contact iShares Canada and here is their reply:

    “Hi Rob,

    Thanks for your inquiry. You are correct to conclude that IGT is a Canadian version of IAU with the same exposure. It also carries the same MER.

    Here is a link to the U.S website where you can see all the information about IAU (IGT).

    http://us.ishares.com/product_info/fund/overview/IAU.htm?fundSearch=true&qt=IAU

    Best regards,

    The iShares Team”

    So it looks like the IGT is cheaper than the CGL C (non hedged) ETF.

    IGT Management (or sponsor) Fee — 0.25%
    CGL C Management Fee — 0.50%

    I do not know why anyone would buy the Claymore CGL C ETF when you can buy the IGT with lower management fees (unless one cared about where the gold is stored). According to the iShares USA website, the IAU/IGT ETF stores the gold in various countries including Cda, USA and UK etc. In contrast, it appears that the CGL C ETF stores the gold in Canada.

    Now I just have to be patient and wait for a pullback in Gold before I buy some IGT:-)

  14. Rob November 3, 2012 at 9:35 am #

    Can anyone comment on the Gold Exchange Traded Receipts (ETR’s) offered only to Canadians by the Royal Canadian Mint? They are traded on the TSX under MNT and MNT.U.

    See http://www.reserves.mint.ca

    What are the advantages and disadvantages vs. an ETF?

    Are there are management fees for the MNT ETR?

  15. Claude November 21, 2012 at 4:08 pm #

    FROM CGL prospectus:

    http://ca.ishares.com/content/stream.jsp?url=/content/en_ca/repository/resource/prospectus/cgl_prospectus_en.pdf

    Exchange Rate Risk
    All redemptions in respect of the Non-Hedged Units will be determined by reference to the U.S. dollar
    price of Bullion. All Canadian dollar redeeming Unitholders will receive any cash amount to which such Unitholder
    is entitled in connection with the redemption in Canadian dollars, and will be exposed to the risk that a strong
    Canadian dollar in relation to the U.S. dollar will result in a lesser redemption amount for such Unitholder.

    Your comments ?

    Same with MNT on TSX ?

  16. Canadian Couch Potato November 21, 2012 at 4:12 pm #

    @Claude: I’m not sure I understand this risk, since a decline in the US dollar relative to the loonie does not mean that an ounce of gold loses value. I would suggest you contact iShares directly and ask them to clarify the risk. They are quite good at responding to investor questions.

  17. Claude November 21, 2012 at 4:21 pm #

    Thanks. The non-hedged : CGL.C and also……MNT .

    Your opinion on MNT ?

  18. Canadian Couch Potato November 21, 2012 at 4:35 pm #

    @Claude: I have not looked closely into MNT, but perhaps I will in a future post. Have you looked at IGT?

    http://canadiancouchpotato.com/2011/07/25/ask-the-spud-ishares-gold-trust/

  19. Claude November 21, 2012 at 4:43 pm #

    Yes. But, i appreciate when you say : “……Using currency hedging in a gold ETF is an interesting strategy, because historically the US dollar and gold have been negatively correlated: when one goes down, the other tends to go up……” So…..the hedge one ….
    CGL….will be my choice….soon. Thanks.

  20. The Pro December 13, 2012 at 10:40 pm #

    I am afraid this post is very misleading and I sense a high level of confusion about currency risks.

    Let me try to explain.

    The base currency of your portfolios is CAD. You make contributions in CAD and you withdraw in CAD.

    Regardless of the assets in your portfolio, the fundamental question here is whether you would like to be exposed to other currencies or not.

    Case #1 – You think that the CAD is a fine currency and the risks for a significant depreciation in long term are minimal.

    Under this scenario you have to avoid purchasing of foreign currency or every time you buy an asset denominated in USD, EUR, JPY etc. you have to make sure that the currency risk is removed from the equation. There are two ways to do that – you either buy the asset hedged to CAD or you buy protection on your currency exposure.

    In your particular case, you simply buy CGL. The other way is to buy USD with which you buy IAU and you hedge the purchase of the USDs by selling the equivalent in USDCAD. If properly hedged, in both cases you will get the return of the asset XAUUSD in CAD.

    Case #2 – You think that the CAD is grossly overvalued and the risks for a significant depreciation in long term are big and/or you think your exposure to CAD should not be bigger than the weight of Canada in MSCI World.

    You have two options here:
    1) Construct the portfolio as in Case #1 and then add a currency overlay hedge
    2) Purchase assets that are not denominated or hedged to CAD

    I would go with the MSCI overlay, but for you it might be easier and more intuitive to buy assets with currency exposure. The later can be achieved by buying CAD listed assets that are not hedged to CAD, i.e. IGT (you buy units in an ETF which converts your CAD into a currency and then invest in a foreign asset), or by converting your CAD into a currency with which you buy the asset, i.e. IAU.

    Hope it helps. Cheers.

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