Posted 6th December 2023

Gold ETF vs Physical Gold: Which is the best investment?

gold etfs vs physical gold investment

Gold and silver remain very popular choices for investors. First, investing in – even a small amount of – gold diversifies risk across your portfolio. And, second, this recognised safe haven asset class offers financial protection when the stock market is particularly unstable.

There are multiple ways to hold gold as part of your overall investment strategy. You can buy physical gold yourself or purchase one of the many gold-backed exchange-traded funds (ETFs) that have sprung up in the last decade. 

In this article, we examine the pros and cons of investing in physical gold and exchange-traded gold.

Physical gold ETFs vs physical gold

With a physical gold investment, you own the gold itself. 

With a gold ETF, you buy into a managed fund investment opportunity designed to track the price of the precious metal. You don’t own any gold yourself, however.

etfs gold anatomy

Gold ETFs

The number of gold ETFs to buy has mushroomed in recent years. The biggest of them all is the SPDR Gold Trust with $51bn in assets under management.

Benefits of Gold ETFs

With exchanged traded commodity investments, you don’t handle the delivery and storage of the commodity. This is true for all precious metal ETFs and gold exchange-traded funds.

Fund managers have the primary task of overseeing and managing the structure of the gold ETF. Their key role is to make sure the gold ETF price closely matches the actual market price of gold. 

This is crucial as the goal of a gold ETF is to mirror the movements of the gold spot market price.

There are two types of gold ETF funds: physical ETFs and commodity ETFs. 

ETFs in physical gold own and hold the gold bullion themselves in a vault, whereas commodity ETFs are mutual funds whose purpose is to track the gold price. 

This can be through physical ownership of gold or investing in financial instruments. These instruments include swaps, futures, and shares in gold miners. 

There are two ways in which a commodity ETF might own physical gold:

  • Allocated gold: The ETF owns specific bars of gold, giving it direct ownership.
  • Unallocated gold: The ETF doesn’t have a claim to any specific bullion. Instead, it’s a creditor to the seller of the gold provider.

  • This introduces counterparty risk meaning that if the gold provider fails, the ETF will lose out.

The swaps, contracts and derivatives commodity ETFs used to track the gold price also involve counterparty risk. Allocated gold-backed ETFs can have relatively lower counterparty risk in that regard but they cost more and can be less liquid.

The value of commodity ETFs is also subject to swings in the prices of their investments. This could be share prices in a gold mining company going down or interest rates going up.

If interest rates go up, many fund managers will sell some of the gold they hold because owning gold doesn’t pay a dividend or interest. They could then choose to invest the proceeds in gold-related bonds or stocks.

Gold ETFs are highly liquid meaning you can buy and sell them quickly; this is despite the occasional complexity of the assets commodity ETFs hold and the risks associated with those assets. 

Physical ETFs lack this complexity as their sole investment is in gold bullion.

In one sense though, both types of gold ETFs are unsophisticated investments because their core function is to track the gold price. Having that one goal makes them more cost-effective for investors than other types of funds, with the caveat being that they do not offer true ownership of gold. You can’t redeem a holding in an ETF for gold. Instead, you’re paid out in the equivalent amount of cash.

gold bar anatomy physical bar

Physical gold

Even the best gold ETFs don’t offer investors the chance to own physical gold. You can own physical gold in various forms from decorative jewellery to coins and investment-grade bullion bars.

People, governments, and investors have recognised the value and lustre of gold for millennia, since the times of Ancient Egypt and as far back as the Mayan and Incan civilisations of Central and South America.

Benefits of investing in physical gold

Investors and central bankers alike widely consider gold as the ultimate safe haven.

After centuries of human conflict and financial crashes, the buying power of an ounce of gold has remained constant.

When a crisis strikes, many investors would rather own the physical metal than invest in even the best UK Gold ETF.

Physical gold is also a currency, which you can easily exchange for cash or goods and services. Societies around the world recognise the intrinsic value of gold and it is why many central banks choose to hoard gold in times of economic turmoil.

Investing in physical gold is strategic, according to Kinesis’ Head of Content, Douglas Turner:

“Some investors may wonder whether gold still carries the importance in today’s society that it once did. To see that this is true, one need only look at the significant gold holdings on the balance sheets of central banks and other financial organisations... Several central banks have recently added to their gold reserves, evidencing their faith in gold as a sound store of value.”

Gold, as an asset class, behaves differently from other asset classes. When market uncertainty sees the prices of other asset classes dwindle, gold is often immune to these same triggers.

When you own gold, you don’t require third parties to sell them for you. If you do need to liquidate your gold, you can do so bilaterally or sell it to a dealer.

The main downside of holding physical gold is storage. Storage costs alone make physical ownership of a quantity of gold more expensive than holding it via an ETF.

What are the main differences between gold ETFs and physical gold? 

The most important difference between physical ownership and investing in an ETF is the actual ownership of the gold.

With physical gold, you own the precious metal in the form of coins, bars, or bullion.

With a physical gold ETF, you own a share of a fund that holds physical gold, but you do not own the gold directly. 

With commodity gold ETFs, you own a share in a fund that tracks the gold price. The fund tracks in different ways from investment in futures and swaps and owning allocated or unallocated gold.

If your fund invests allocated gold bullion, it has specific gold bars that it owns and is its property. With unallocated gold, it has a claim to an amount of gold but no claim to specific bars or pieces. In either case, your ownership is indirect. You own a share of the fund, not the gold or the financial instruments it owns or uses.

The (counterparty) risk of holding commodity gold ETFs can be significant, especially if they invest heavily in derivatives like futures and swaps. If the entities issuing these instruments become insolvent, the fund loses its money. The chances of a gold ETF completely failing and being unable to pay its investors are generally low – but a collapse is not impossible.

At first glance, buying any type of gold ETF may appear more straightforward than buying physical gold. It’s easy to buy and sell your ETF holdings and the transaction fees on gold ETFs in the UK are low and the spreads tight.

That said, the question of whether an investor should pass over the security of true ownership of physical gold is a pertinent one, if they want to take advantage of all the benefits of holding gold in their portfolio. 

As more and more online digital platforms open up access to physical gold, investors no longer need to give up on physical, allocated ownership for trading ease and liquidity.

Which is better: gold ETFs or physical gold?

The only true way for an investor to benefit from the protection of gold is to own it in its physical form. 

Even the best gold funds in the UK present investors with counterparty risks. The often heavy reliance of commodity ETFs on financial instruments also presents another danger. These investments could also fall victim to the same systemic risks that have seen other assets and funds fall prey to over the years.

Online platforms like Kinesis make gold investment as straightforward as possible, balancing the security of owning physical gold with the liquidity, lower costs, and convenience of gold ETFs.

Kineses also removes the pricing advantage that gold ETFs traditionally provide, bringing investors gold at a rate only a fraction higher than the spot price.

Users also have access to the precious metals liquidity via Kinesis’ strategic partner, Allocated Bullion Exchange. Platform users can hold their metals within a secure global vaulting network, all while paying 0% storage fees.

Open a free Kinesis account today, to start your gold investment journey.

This publication is for informational purposes only and is not intended to be a solicitation, offering or recommendation of any security, commodity, derivative, investment management service or advisory service and is not commodity trading advice. This publication does not intend to provide investment, tax or legal advice on either a general or specific basis.