Physical Gold vs Gold ETFs

It is a popular opinion that buying gold is a safe haven for all, especially in turbulent times, which is why gold has consistently remained one of the favourite buys among the investors to hedge their risks. That said the two different ways of owning gold, through ETF or physical stock, have very different specifics and risks attached to it.

Owning a gold ETF is very convenient – it’s easy to trade, there’s no cost of storing the physical stock and there’s no risk involved in someone breaking into your vault stealing your investment. Another advantage is that it’s possible to apply leverage with options – which is risky but is not something which can be done with owning physical bullion.

With that in mind it is worth noting here that the gold ETF is a financial product and as a result carries a degree of risk. In theory one of the main reasons for buying gold tends to be in creating a last resort risk hedging investment to carry the investors through the turbulent times or the times of crisis. However it’s the banking systems that tend to be under strong pressure through the crises making the gold ETFs a part of those systems – thus significantly escalating their risk rating.

The system works in the following way – the custodian is used (for example HSBC does this for the GLD fund – the largest gold ETF in the market) to source and store gold. With this in mind trust in the custodian bank is of paramount importance as you need to have confidence that said custodian will not be impaired when the crisis hits (HSBC in this example if the GLD ETF is bought). As in the case of systemic disruptions and 2008 style crises there cannot be such guarantee as a large proportion of market participants are affected. Additionally, the custodian may employ a sub-custodian to source and store gold which adds another risk layer to the system.

ETFs carry counterparty risk where an investor relies on another party for their investment. Gold ETF makes an investor susceptible to a number of risks to include but not limited to – 1) fund structure, 2) regulatory oversight, 3) operational integrity and even things like delivery.  Is the fund protected by adequate insurance? If anything in that chain breaks down your investment is at risk.

Another aspect worth noting with the gold ETFs is the availability of its physical delivery – as a general rule you would need to own a lot of shares in order to be able to redeem that gold. For example, GLD requires that at least 100,000 shares are owned in order for the physical delivery to be requested – that on average means millions of dollars of investment. Other factors are at play – such as, only the delivery of 400-ounce bars is permitted, the recipient must pay all settlement and charges and the fund reserves the right to settle in cash. Even though a number of smaller funds permit smaller quantities of deliveries, on average all the main ones have similar requirements to the one of GLD. So unless you invest a large amount of money into the fund you cannot redeem it as stock.

In considering buying physical gold one of the major issues was the cost of storing physical gold which acted as a major deterrent – however, in the current market, with the interest earned on cash hovering close to zero, the opportunity cost of holding gold has been reduced to a minimum. It is in many instances cheaper to hold physical gold than paying the fees for owning a gold ETF.

When you buy gold bullion there is no risk of default and it doesn’t require backing of any financial institution, government or brokerage firm. In addition, gold is highly liquid meaning you can easily convert it into cash. It’s also portable – you can hold up to $50,000 in a small coin tube. It’s a durable investment unlike agriculture products and very easily divisible – unlike diamonds which change in value when split up.  To sum up, if you’re looking for a hedge on your investments or for the safe haven through the turbulent times buying physical bullion may prove safer than investing in gold ETFs.