Fragile When It Matters: Regimes, Spillovers, and the Structural Determinants of Gold ETF Tracking Errors
This study reveals that gold ETFs, often marketed as crisis insurance, exhibit significantly degraded tracking fidelity during stress periods due to cross-market spillovers and structural hierarchies, rendering them least reliable precisely when investors need them most.
Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer
Investors often turn to gold when the world feels unstable, viewing it as a reliable anchor against economic storms. To make buying and selling this precious metal easier, financial markets created exchange-traded funds, or ETFs. These are investment vehicles that hold physical gold bars in a vault and sell shares to the public, promising that the price of a share will move in perfect lockstep with the price of the gold it holds. For years, the financial industry has treated these funds as crisis insurance, assuming they would work best precisely when investors needed them most. However, the mechanics of how these funds operate rely on a complex system of traders who constantly buy and sell shares to keep the price aligned with the gold value. When markets are calm, this system works smoothly. But when panic strikes, the very conditions that drive people to gold can jam the gears of the system that keeps the price accurate.
A team of researchers from Universiti Malaysia Terengganu set out to test whether this "crisis insurance" actually holds up when the pressure is highest. They examined the daily performance of 71 gold funds across ten different countries, looking at data from 2019 through early 2026. This period included some of the most turbulent times in recent history, including the global pandemic, the war in Ukraine, and a major banking crisis. Instead of just asking how close the funds usually stay to the gold price, the researchers asked a more urgent question: what happens to that accuracy when the market goes into a tailspin? They found that the relationship between the fund and the gold is not a steady line but a fragile one that breaks into distinct states. In calm times, the funds track the gold price with high precision. But when volatility spikes, the funds enter a "stress regime" where the error between the fund price and the gold price widens dramatically, often by three to four times the normal amount.
The study revealed that this breakdown is not random; it is predictable and driven by fear. The researchers discovered that when the market's fear gauge, known as the VIX, rises, the funds are much more likely to slip into this high-error state. Once they fall into this state, they tend to stay there for several days, rather than snapping back to normal immediately. This means that during a crisis, the tracking error is not just a series of bad days, but a sustained period of dysfunction. The analysis showed that nearly two-thirds of the variation in how well these funds track gold comes from forces that move across borders, linking the performance of funds in one country to events in another. This global connection is so strong that the funds in different nations essentially move together, reacting to the same underlying stress.
Perhaps the most surprising discovery was the direction in which these problems spread. Conventional wisdom suggested that the United States, being the largest and most liquid market for gold, would be the source of these tracking errors, with smaller markets copying its mistakes. The data proved the exact opposite. The United States actually acts as a shock absorber, absorbing errors from other markets rather than creating them. The tracking problems originate in the periphery, particularly in Switzerland and several Asia-Pacific markets, and flow toward the US. This happens because the US has a deep, robust system of traders who can quickly correct price mismatches, while other markets have thinner systems that generate larger errors. When stress hits, these larger errors from the periphery ripple through the global system, but the US market's depth allows it to dampen the impact rather than amplify it.
The researchers also identified a clear structural hierarchy among the nations. The United States sits at the top with the most accurate funds, where the tracking error is typically around 11.3 basis points. Canada, the United Kingdom, and Germany follow in a second tier of efficiency. At the bottom are five Asia-Pacific markets, including Australia, India, and Japan, where the tracking error is significantly higher, reaching up to 98.3 basis points. This gap is not just a matter of financial development; it is a matter of specific infrastructure. Markets with better access to physical gold delivery and more competition among the traders who manage the funds perform better. The study found that these structural weaknesses interact with crises in a dangerous way. A shock that might raise the tracking error in the US by 13 basis points could raise it by more than 50 basis points in a market like Australia or South Korea.
Ultimately, the study concludes that gold ETFs are most fragile exactly when they are needed most. The funds that investors buy as a safe haven during a crisis are the very ones most likely to fail at their primary job of tracking the gold price accurately. This failure is not uniform; it hits the markets with the weakest infrastructure the hardest, and it happens most severely during the moments of highest stress. The research suggests that investors should not treat all gold funds as equal, as the country where the fund is based is a critical risk factor. For regulators and fund managers, the findings point to a clear path forward: improving the infrastructure for physical delivery and encouraging more competition among traders can make these financial tools more reliable when the world is in turmoil. The data shows that without these structural improvements, the promise of gold as a perfect crisis shield remains incomplete.
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