Investors are regularly advised to include a small proportion of gold within their portfolio with the precious metal desirable both as a means of diversification as well as a safe haven asset to offer protection at times of stock market jitters.
But what is the best way for an investor to increase their exposure to gold, is it in physical form or via one of the many exchange-traded funds (ETFs) that have sprung up in the last decade?
This article will look at the pros and cons of both forms and explore the difference between these two investment options.
Gold ETFs vs physical gold
In simple terms, a gold ETF is an investment in a fund that seeks to mirror the price of gold while physical gold is ownership of the metal itself.
The number of gold ETFs available has mushroomed in recent years with the largest of them, SPDR Gold Shares, launched back in 2004. It now has more than $53 billion worth of assets under management.
Benefits of gold ETFs
The main appeal of gold ETFs is the ability to gain exposure to the gold price without having to worry about where to store the physical metal itself and the associated charges that go with it. ETFs are highly liquid so an investor can buy or sell at any time and given the unsophisticated nature of the product, with just one asset class to track, the management charges are smaller than more actively managed funds.
Rather than owning gold itself, an investor of an ETF is buying shares in that fund with the price of that fund subject to its own pricing dynamics. However, given gold ETFs are designed to track the price of the metal itself with the amount held in investment supposed to be backed up by equivalent holdings in gold, these ETFs typically trade at very close proximity to the underlying asset.
It is important to note that while gold ETFs track the price of gold, they do not offer investors ownership of gold itself and holdings in an ETF can’t be redeemed for gold but instead are paid out in the equivalent amount of cash.
Physical gold is available in various different forms, from decorative jewellery to coins and investment-grade bars. The value and lustre of gold have been recognised for millennia, dating back as far as the ancient Egyptian empires and as far away as the Mayan and Incan civilisations of Central and South America.
Benefits of investing in physical gold
Gold is viewed as the ultimate safe haven asset, having endured centuries of human conflict and financial crashes with an ounce of gold retaining a similar buying power throughout. At a time of crisis, holding physical gold, rather than in digital form on an ETF or equivalent, enables the holder to easily exchange that coin or bar for cash or another desired good and is recognised around the world. Gold is also an asset class that is uncorrelated to others, so can often outperform when other assets are losing money.
Once bought, physical ownership of gold provides the holder with no counterparty risk as that bar or collection of coins is the holder’s alone, no third party is required for onward sale, and the items can be easily sold either to a dealer or even bilaterally. The main downside of holding physical gold is the need to find a safe place to store the metal, which typically makes it more expensive to own than an equivalent quantity bought via an ETF.
What are the main differences between gold ETFs and physical gold?
The crucial main difference between the two investment forms is that only via physical gold does an investor actually own gold itself. An ETF only offers an equivalent amount of gold and if the trust operating the ETF were to collapse, there is a chance an investor won’t get back their original investment. (Admittedly, the chance of a gold ETF failing to such an extent that it was unable to pay out its investors is much more unlikely than other asset classes as the value of the gold held should cover redemptions.)
An ETF can be easily traded at any time with tight spreads and small transaction fees. Physical gold is slower to sell as the asset would need to be seen in person by the prospective buyer but once that hurdle is overcome, there is a highly liquid market to sell into, with internationally recognised standards around quality to protect both parties.
Which is better: gold ETFs or physical gold?
Given that gold is seen as an investment to protect against collapses of the financial system, the only true way for an investor to have this protection is by holding it in its physical form, removed from any counterparty risk. A gold ETF is another financial instrument and ultimately could fall victim to the same systemic risks that have seen other assets and funds fall prey to over the years.
To achieve the best of both worlds, the Kinesis platform offers the secure trade and management of physical gold bullion with all the liquidity, low costs and convenience previously associated with gold ETFs. Kinesis eliminates any meaningful pricing advantage of gold ETFs, with physical bullion priced a fraction above the spot price.
Kinesis gives users access to limitless precious metals liquidity through their strategic partner, Allocated Bullion Exchange – a leading exchange that has facilitated precious metals trading for institutions for over 10 years. Through ABX, investors and traders can benefit further still from the ability to hold their metals within a secure global vaulting network, while paying 0% storage fees.
Rupert is a Market Analyst for Kinesis Money, responsible for updating the community with insights and analysis on the gold and silver markets. He brings with him a breadth of experience in writing about energy and commodities having worked as an oil markets reporter and then precious metals reporter during the seven years he worked at Bloomberg News.
As well as market analysis, Rupert writes longer-form thought leadership pieces on topics ranging from carbon markets, the growth of renewable energy and the challenges of avoiding greenwash while investing sustainably.
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.