How to Invest in Gold, Silver ETFs

2014-10-10

NEW YORK ( TheStreet) -- Both bulls and bears have been flocking to precious metals ETFs such as the iShares Silver Trust (SLV) and Market Vectors Gold Miners (GDX) to exit currency holdings and fight inflation fears.

The list of silver and gold exchange-traded products continues to grow, and it has become increasingly important for investors to understand these different types of products as regulation shapes the industry.

No matter which way you think the market is headed, there are compelling reasons to gain exposure to gold. Bulls can use gold as protection against inflation, and in case the dollar weakens as the stock market surges. Bears can turn to gold to protect their capital against market downswings.

Silver, the more volatile of the two metals, tends to soak up the spill-over from its yellow counterpart. Silver may not always follow an upswing in gold, but high inflation fears will drive investors to both. In addition to currency protection, silver also has uses as an industrial metal.

As the Commodities Futures Trading Commission investigates the role that futures-based commodity funds have on the markets they track, investors need to be aware of which type of ETF they buy. Futures-based gold and silver funds could be profoundly affected by new position limits, while physical and equity-based funds are unfazed.

Physical ETFs

These funds track the value of gold by holding physical gold and silver in storage. As assets in the funds increase or decrease, fund managers will adjust their stocks of bullion accordingly. Physical gold ETFs also have a higher tax rate than many of their peers: they are taxed as collectibles, with a 28% percent long-term capital gains rate.

Here are two gold ETFs: SPDR Gold Shares (GLD) and iShares COMEX Gold (IAU).

There is no difference between the funds except that GLD has 30 times the assets and volume of IAU. While GLD is larger, both funds have high liquidity. Investors can buy and sell shares of both GLD and IAU near their underlying values.

Silver

Here are two silver ETFs: Silver Trust (SIVR) and iShares Silver Trust ETF (SLV).

SLV is a well-established physical silver ETF, with more than 8.5 million shares changing hands on an average trading day. SIVR was just launched this summer and will take time to garner investor interest that is comparable to SLV. While SIVR is gaining speed quickly, investors should stick to SLV until the new fund is more established.

Futures ETFs

These funds, which hold gold futures contracts and are organized as partnerships, belong to a group of exchange-traded products that have come under intense scrutiny in recent weeks. The CFTC is currently considering limitations on the number of futures contracts that certain funds can own, limiting the size of some exchange-traded products.

None of the three products listed below is conspicuously large. The two ProShares gold funds, however, could face double regulations in the future. Since they are futures-based, they could suffer from a CFTC crackdown, while their leverage could draw the ire of FINRA.

They are taxed as futures, with 60% at the long-term capital gains rate and 40% at the short-term capital gains rate. Investors will be responsible for taxes on these funds each year and will receive a Schedule K-1 form.