For funds that own gold, crude and other hard assets, select from these bargains.
The Fed has been printing money as if it were going out of style. Defense? Gold. Commodities.
This survey covers the most cost-efficient portfolios for precious metals and other commodities: one mutual fund and 12 exchange-traded ones that have annual holding costs of 0.4% or less. The biggest of the lot is SPDR Gold Shares, with $77 billion, but, as you will see, there are cheaper ways to own bullion.
The tables are sortable. If you are a speculator, daily volume is important (and SPDR Gold Shares wins out). If you are a long-term holder, expense ratios matter.
This story closes with some important tax advice.
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Do understand that gold is an imperfect insurance policy against inflation. If the hedge were perfect, the chart of gold’s real price would be flat. As you can see, the metal has recently reclaimed its 1980 high, but only after a long struggle. There was a bad 20-year stretch from 1980 to 2000.
The same is true of diversified commodity baskets (containing gold, silver, oil, gas, copper, hogs, wheat and whatnot). They performed well in the rising inflation of the 1970s but not well after that.
In the past decade the Invesco DB Commodity Tracking fund (DBC)
And yet, as the war on coronavirus winds down, pent-up demand and lavish economic stimulus might give rise to a spike in inflation. And that spike might make a commodity hedge valuable. It is probably the fear of just such a run-up in the CPI that created this year’s bull market in gold.
Advice to those considering a commodity fund:
Watch expenses. Especially if you will be in for the long haul. At 0.85%, that DB fund doesn’t make the Best Buys cut; in 20 years its fee would erase 16% of your money.
Not just the operator’s fee eats into returns. Many commodities, notably including gold, trade in contango, meaning that the future you buy goes for a premium over the spot price. The spread reflects the costs of storage and financing. The commodity has to appreciate faster than that spread for you to come out ahead.
Some funds have indirect costs via the derivatives they use. Vanguard’s year-old Commodity Strategy, a mutual fund, has a low expense ratio of 0.2% but also gives up 0.13% to some banks. These middlemen sell total-return swaps that deliver the return on a commodity index.
Consider buying producers. Rather than own oil and gold futures, you could own shares of oil drillers and gold miners. Instead of paying for storage you’d be collecting dividends. The Guide To Sector Funds includes Fidelity MSCI Energy, with a dividend most recently delivering a 4.8% annual yield.
Beware taxes. There are three ways for shareholders in a commodity fund to be taxed. The last of the three is bad news.
The first arrangement, common for gold and silver, is a trust that turns your investment into a “collectible,” with gains taxed federally at a maximum 28% rate (plus 3.8% for Obamacare). You owe tax if and when you sell the shares. That rate is stiffer than the rate on shares of Tesla or Amazon, so it’s usually a good idea to stuff bullion ETFs in a tax-deferred account while using your taxable account to hold other equities.
The next arrangement is a partnership. The DB fund uses this one. At tax time you get a K-1 form, which causes gains and losses on most commodity futures to flow onto your 1040 with a 60/40 blend of long-term and short-term treatment. These gains and losses show up even if you don’t sell the fund and even if the fund doesn’t make any distributions. This is not too bad a deal, except for one peculiarity: The management fee becomes nondeductible. So if you make 5% before expenses, and 4.15% after, you pay tax on 5%.
The third arrangement is a fund that invests in a spooky Cayman Islands subsidiary, which in turn invests in futures or swaps. This is the scheme for most of the diversified commodity funds created in recent years, including all three of the diversified Best Buys. It spares you having to look at a K-1. That’s the only good thing about it. Otherwise it’s a tax disaster.
Suppose you buy a share of a K-1-free fund for $24 and it loses money on its commodities, sinking to $14. The $10 of losses cannot be used or carried forward by the fund. Suppose that in the next calendar year the fund recovers to $24. At that point the fund is compelled to send you a $10 dividend, all of it in the form of ordinary income.
As soon as the dividend check goes out, your fund share goes down in value to $14. If you leave at that point you have a $10 long-term capital loss to claim.
This is toxic. You’re breaking even, yet you have $10 of high-taxed ordinary income to report, coupled with a potential $10 capital loss that might, depending on what else you have going on, do you no good at all. The capital loss cannot offset the dividend.
I could find none of this horror story disclosed in any prospectus. I did, however, ring up Vanguard and got a full confession from an expert there. His advice: If you want to own our fund, please do so in a tax-deferred account.
Wondering how this weird tax treatment came about? It’s the intersection of one law making commodities forbidden fruit for investment companies, and another one aimed at punishing people who try to avoid tax by parking securities on yachts moored in the Caribbean.
My advice on commodity plays:
—For a bullion fund, select something with a low expense ratio and a decent amount of trading volume. Prefer your IRA as the place to hold it.
—For diversified exposure, buy the Vanguard product (minimum investment, $50,000). Don’t own it unless you can find room in the IRA.
Details on the Vanguard fund are hard to find on its investor pages. This link to Vanguard’s advisor pages may be helpful.
