There are currently 3 channels to invest in paper gold - Etfs, gold fund of funds and electronic gold. As ETFs are the most common, we will provide a little background understanding of these gold products.

Gold ETFs are being introduced in 2007 just before the financial tsunami. A gold ETF will typically invest 90-100% of their fund in bullion with the rest of 0-10% in money market funds. It aims to provide returns as close as possible to that of the price of gold itself. As noted, there could be various intermediaries and custodians in the process.

Through gold ETFs, investors gain an entry to be involved in the precious metal market without going into the hassle of purchasing real gold bullion which could be a hassle. Purchases and sale could be made easily just like the trading of a security.

While they provide a series of advantages such as affordability and liquidity, potential investors should be very mindful on the following counts.

Rules of the game: It is crucial that investors learn the basic fundamentals of investing in gold ETFs. There is usually no entry/exit load bought or sold but the investor would have to bear a cost in terms of brokerage for trading these ETFs units. The price of units in the secondary market will often reflect the price of one unit of gold. The NAV would reflect the value of the underlying gold.

Tracking error: As highlighted in my previous post, there is tracking error involved due to the nature of how these ETFs are being computed using a variety of swaps and other forms of derivatives. When these funds lag behind, it gives rise to a tracking error. In addition there could be other enpenses and factors that result in the performance of ETFs differing from that of the actual gold prices. I have highlighted this phenomenon in my previous post. Investors must be mindful that these differences do occur and they could eat into the returns pretty substantially.

Fund house credentials: As gold ETFs follow gold prices, evaluating these funds may be largely based on the track record of the fund house and the various post investment support it provides.

Hidden Costs: Often such funds will charge a management fee although they will be much smaller than those charged by mutual funds or hedge funds. Do note of other hidden costs which might be involved. Investors should always opt for the fund which charges the least recurring expenses since there is no need for active management in such a fund.

Comparison across gold ETFs: It is imperative to make comparison against other gold ETFs to see which is the most cost effective product. In addition, minimum tracking error and low management cost will be criteria that potential investors should look at in terms of evaluating which gold ETFs to purchase.

Gold is a crucial asset to own during inflation and a good hedge against rising prices. However, we do believe that the most part of the world, especially the western developed nations are currently in a period of deflation, hence gold might already have started a move lower that might persist in the months ahead.

If an investor believes in the long term fundamentals of gold, then there is every reason to include it as part of an asset class in the portfolio. They should always be mindful of maintaining an optimum asset allocation mix depending on their risk profile.

Over here, we still believe in the holdings of physical gold as compared to paper gold.