Physical Gold or Gold ETF Investment. Which is Better?

Regardless of the watered down numbers published, China has been buying up gold with a vengeance.  The CME reported that precious metal purchases in February were up 48% over last year. Precious metal ownership and investment is becoming more and more important, and the stock market ether is beginning to wear off. Nevertheless, people are flocking to metal ETF’s. Some investors say they enjoy the convenience of “owning metal without the hassle of storage.” But is that really what they’re getting?

The thing that makes gold a “safe haven”, is the fact that it appreciates when most other investment instruments falter (or fail) and you own and hold a physical asset. But if you own a gold ETF, do YOU really OWN a physical asset? Bloomberg recently reported that, “There’s a Rush for Gold ETF’s.” They report that “scared investors” are looking for safety. But a concerned person choosing an investment tool for “safety” must certainly be considering a “worst case scenario.” And in a worst case scenario, safety would dictate that you have free and immediate access to your physical metal investments. However, a recent report explains that there is only around 1 physical ounce of gold for every 330 ETF “paper” ounces.

If the economy were to take a sudden turn for the worse, it naturally follows that there would be a rush to liquidate paper ownership for physical metal, but if only 1 out of every 330 “owners” can take physical ownership, where’s the safety in that?

Here are a few other facts that investors concerned with “safety” should clearly understand:

• Page 11 of GLD’s prospectus clearly states that there is no entity responsible for verifying the fineness or quality of gold held in the vault. So, not only do the bars NOT need to add up to the amount of gold needed to cover the shares printed, but the bars in the vault don’t need to meet a minimum fineness.
• The ETF trustee does not insure the gold. It’s the responsibility of the custodian and their liability is limited to damages to the gold they directly inflict. So realistically, if the bars in the vault are lead painted gold, then as long as the custodian can show that these are the bars originally deposited, they would be protected and the trustee wouldn’t be liable.
• The prospectus also states that the custodian is free to store the gold with sub-custodians until the gold is delivered to the custodian’s main vault, meaning the gold can be in various places at once. Sub-custodians are typically banks who are not responsible for the gold they store, are free to appoint other sub-custodians, and according to the prospectus, “failure by the sub-custodians to exercise due care in the safekeeping of the Trust’s gold bars could result in a loss to the Trust.”
• Finally, considering that most sub-custodians are banks, if they fail, the Trust becomes an unsecured creditor.

What are Gold ETFs?

Gold Exchange-Traded Funds (ETFs) are investment funds that provide an easy way to invest in gold without physically owning the metal. These funds are traded on stock exchanges, similar to stocks, and are designed to track the price of gold. When you invest in a gold ETF, you’re buying shares in a trust or a fund that holds large quantities of gold bullion. The performance of gold ETFs closely mirrors the market price of physical gold, offering investors exposure to its value while eliminating the need for storage and insurance associated with physical gold ownership.

Benefits of Investing in Gold ETFs

Investing in gold Exchange-Traded Funds (ETFs) offers a range of advantages, particularly for those seeking exposure to gold without the logistical challenges of handling physical gold. Here are some key benefits:

Ease of Investment and Liquidity:

Gold ETFs are traded on stock exchanges, which means they can be bought and sold like any other stock through a brokerage account. This ease of trading provides high liquidity, allowing investors to quickly and efficiently adjust their holdings in response to market movements or personal financial needs.

Lower Costs and No Physical Storage:

Unlike physical gold, investing in gold ETFs does not require paying for storage or insurance. This absence of material storage costs makes gold ETFs a cost-effective option for gold investment. Furthermore, the transaction costs of buying and selling gold ETFs are typically lower than those of physical gold.

Portfolio Diversification:

Gold ETFs offer a convenient way to diversify an investment portfolio. Gold often has an inverse relationship with other asset classes, which means it can act as a hedge against market volatility and inflation, providing a buffer in economic downturns.

Purity and Authenticity:

The gold-backing ETFs are typically of high purity, and investors don’t have to worry about the authenticity or quality of the gold, which can be a concern with physical gold.

Transparency and Simplicity:

Gold ETFs provide transparency in pricing. Investors can track the current price of gold ETFs easily, just like any stock, ensuring clarity in the value of their investment. The simplicity of trading gold ETFs makes them accessible even to novice investors.

Tax Efficiency:

For investors using taxable accounts, gold ETFs can offer more favorable tax treatment than physical gold in some jurisdictions, depending on the local tax laws and regulations.

Gold ETFs represent a practical and efficient way to include gold in investment portfolios. Their ease of management, cost-effectiveness, and liquidity make them popular among many investors. While they offer several advantages, it’s crucial to consider them as part of a diversified investment strategy.

Benefits of Investing in Physical Gold

While gold ETFs offer convenience and ease of management, investing in physical gold has distinct advantages, appealing to different investor preferences and objectives. Here are some key benefits of investing in physical gold:

Tangible Asset and Intrinsic Value:

Physical gold is a tangible asset, offering a sense of security and permanence that can be appealing during economic uncertainty. As a finite and natural resource, the intrinsic value of physical gold provides a sense of stability that is not matched by paper assets or digital investments.

No Counterparty Risk:

When you own physical gold, you are not reliant on the performance of financial institutions or fund managers. This direct ownership eliminates counterparty risk, the risk associated with the other party in an investment not meeting their obligations.

Privacy and Control:

Physical gold ownership offers a level of privacy and control over your investment. You have direct control over your gold assets and can store and manage them as you see fit. This aspect can be beautiful in times of widespread economic distress or when there are concerns about the stability of financial systems.

Hedge Against Inflation and Currency Devaluation:

Historically, gold has maintained its value over the long term, serving as a hedge against inflation and currency devaluation. Physical gold’s value does not corrode or degrade, and its historical role as a store of wealth continues to hold firm.

Potential for Collectible Value:

Specific forms of physical gold, such as coins or specially minted bullion, can carry collectible or historical value beyond the intrinsic value of the gold itself. This can provide an additional layer of investment potential.

Risks of Investing in Gold ETFs

While gold ETFs offer a convenient and accessible means to invest in gold, they are not without risks. Understanding these risks is crucial for investors to make informed decisions.

Market Risk and Volatility:

Like any market-traded asset, gold ETFs are subject to the fluctuations and volatility of the stock market. The price of gold ETFs can be influenced by various factors, including economic data, geopolitical events, and market sentiment, leading to potential price swings.

Counterparty Risk:

Investing in gold ETFs involves reliance on the management of the fund and the institutions holding the physical gold. This introduces counterparty risk, where the failure of one party to meet their obligations could impact the investment. While rare, issues such as bankruptcy or mismanagement could affect the value of your investment.

Tracking Error:

Some gold ETFs may need to track the price of gold perfectly. This discrepancy, known as tracking error, can occur due to the fund’s expenses, the method of gold price tracking, or the structure of the ETF. It can lead to a difference between the ETF’s performance and the actual price of gold.

Liquidity Risk:

While gold ETFs are generally liquid, there can be instances where liquidity is reduced, such as during extreme market conditions. This could impact the ability to buy or sell shares at desired prices.

Potential for Lower Returns:

Gold ETFs often have associated costs, such as management fees and operational expenses, which can eat into returns. Additionally, because you don’t own physical gold, you miss out on potential gains from the collectible value of gold coins or bars. 

Top Gold ETFs

For investors interested in gold ETFs, selecting the right fund is crucial. Several gold ETFs are available in the market, each with unique characteristics. Here are some of the top gold ETFs that are popular among investors:

SPDR Gold Shares (GLD):

• Overview: Launched in 2004, SPDR Gold Shares is one of the largest and most famous gold ETFs globally. It seeks to reflect the performance of the price of gold bullion.
• Features: GLD offers high liquidity and is often favored by institutional investors. The ETF is backed by physical gold held in secure vaults.

iShares Gold Trust (IAU):

• Overview: IAU aims to track the day-to-day movement of the price of gold bullion. It is known for its relatively lower expense ratio than other gold ETFs.
• Features: This ETF is backed by gold stored in vaults and provides an efficient way to access the gold market. It’s a popular choice among both retail and institutional investors.

VanEck Vectors Gold Miners ETF (GDX):

• Overview: Unlike GLD and IAU, GDX invests not only in physical gold but also in a range of publicly traded companies involved in gold mining. This includes large-cap gold mining companies.
• Features: GDX allows investors to gain exposure to the gold mining sector, which can offer leveraged returns relative to the price of gold. However, it also carries risks associated with mining company performances.

Tax Considerations and Performance Tracking:

When investing in these or any other gold ETFs, it’s essential to consider the tax implications, as ETFs are subject to capital gains tax.

Investors should also closely track the performance of their chosen ETF against the price of gold and the broader market to ensure it aligns with their investment goals.

How are Gold ETFs Taxed?

Understanding the tax implications of investing in gold ETFs is crucial for effective portfolio management and financial planning. Like other investment products, Gold ETFs are subject to taxation, but the specifics can vary based on several factors.

Capital Gains Tax:

Tax on Sale of ETF Shares: When you sell shares of a gold ETF, you may be subject to capital gains tax, depending on whether you’ve made a profit. This tax rate depends on how long you hold the ETF shares. If held for more than a year, they are typically subject to long-term capital gains tax, which generally has a lower rate than short-term capital gains tax, applicable on investments held for less than a year.

Tax on Dividends:

Some gold ETFs may pay dividends to their investors. These dividends are usually taxed as ordinary income. The tax rate can vary based on the investor’s income level and tax bracket.

Collectibles Tax Rate:

Certain types of gold ETFs, particularly those that hold physical gold, may be taxed as collectibles. This can result in a higher maximum capital gains rate than other securities. Understanding the classification of the gold ETF is essential to anticipate the potential tax liability.

ETFs Holding Mining Stocks:

Gold ETFs investing in mining stocks are taxed like regular stock investments. Capital gains from these ETFs are taxed as short-term or long-term, depending on the holding period.

Is Buying Gold ETFs Right for You?

Whether gold ETFs are a suitable investment hinges on individual financial goals, risk tolerance, and investment strategy. While gold ETFs offer certain advantages, some may have better choices. Here are some considerations to help determine if investing in gold ETFs aligns with your investment objectives:

Consider Your Investment Goals:

Gold ETFs can be an excellent choice if you aim to gain exposure to gold as an asset class without the complexities of handling physical gold. They allow you to benefit from the price movements of gold while offering liquidity and ease of trading.

Risk Tolerance and Market Exposure:

Consider your comfort level with market fluctuations. Gold ETFs, like any market-traded assets, are subject to price volatility. Physical gold might be more suitable if you prefer investments that are not directly tied to stock market performance.

Portfolio Diversification:

Gold ETFs can be an effective tool for portfolio diversification. They provide a hedge against inflation and can be a haven during economic downturns. Gold ETFs could be a valuable addition if you’re looking to diversify your investment portfolio.

Long-Term vs. Short-Term Investment:

Determine your investment horizon. Gold ETFs can be suitable for both short-term traders and long-term investors, depending on the trading strategy and the specific gold ETF chosen.

Ease of Management:

If you prefer a hands-off investment that doesn’t require secure storage or insurance, gold ETFs offer a convenient alternative to physical gold. They can be easily managed through a standard brokerage account.

What are the Main Differences Between Gold ETFs and Physical Gold?

When choosing between gold ETFs and physical gold, understanding their fundamental differences is crucial for making an informed investment decision. Each option offers distinct features and benefits, catering to varying investor needs and preferences.

Tangibility and Ownership:

• Physical Gold: Investing in physical gold means owning tangible assets. Investors have direct control over their investment, whether in the form of coins, bars, or jewelry. This physical ownership provides a sense of security and personal connection to the investment.
• Gold ETFs: Conversely, gold ETFs represent a more abstract form of investment. Investors own shares in a fund that tracks the price of gold rather than owning gold directly. This method exposes gold’s price movements without the tangible aspects of physical gold.

Storage and Security:

• Physical Gold: Owning physical gold requires secure storage solutions, such as safety deposit boxes or home safes. Additionally, investors may need to insure their gold holdings, adding to the overall cost.
• Gold ETFs: Gold ETFs eliminate the need for physical storage and insurance, as the fund manager or custodian holds the gold backing the ETF.

Liquidity and Trading:

• Physical Gold: Selling physical gold can be less immediate, involving finding a buyer and potentially verifying the gold’s authenticity and purity.
• Gold ETFs: ETFs offer high liquidity, as they can be quickly bought or sold through a brokerage account during trading hours, similar to stocks.

Market Exposure and Risks:

• Physical Gold: Physical gold is less susceptible to market fluctuations and is often viewed as a stable store of value, especially in times of economic uncertainty.
• Gold ETFs: While ETFs provide convenient market exposure, they are subject to stock market volatility, fund management risks, and tracking errors.

Can Gold ETF be Converted to Physical Gold?

A common question among investors interested in gold ETFs is whether these financial instruments can be converted into physical gold. Understanding the conversion process and its feasibility is crucial for investors considering switching their investment form.

Conversion Policies of Gold ETFs:

Large Institutional Investors: Generally, the option to convert gold ETF shares into physical gold is available primarily to large institutional investors, such as market makers or large-scale fund investors. These entities can exchange many ETF shares, typically known as a ‘creation unit,’ for physical gold.

Retail Investors: The process is more complex for individual or retail investors. Most gold ETFs do not offer a direct mechanism for converting ETF shares to physical gold. Retail investors typically sell their ETF shares in the market and use the proceeds to purchase physical gold if they wish to switch their investment type.

Considerations for Conversion:

Feasibility and Costs: Even for those who qualify, converting ETF shares to physical gold involves various logistical considerations, including storage, security, and potential costs or fees associated with the conversion process.

Market Dynamics: The decision to convert should also consider market dynamics. The timing of selling ETF shares and buying physical gold can impact the overall value of the investment due to market fluctuations.

Investment Strategy Implications:

Investors interested in owning physical gold may purchase gold products directly rather than seeking conversion from gold ETFs. This approach provides more straightforward ownership and control over the physical asset.

Conclusion:

For most individual investors, converting gold ETFs into physical gold is not practical. Instead, investors should clearly define their investment goals and choose the form of gold investment – physical or ETF – that best aligns with their objectives and circumstances. At American Bullion, we assist clients in navigating these choices, providing expertise in physical gold and gold ETF investments. If you’re considering an investment in gold and need guidance on the best approach for your portfolio, contact American Bullion for personalized advice and professional services.

Whether you are new to gold investing or have been a collector for years, it is essential to research and work with a reputable dealer. American Bullion is a trusted resource for those looking to invest in gold IRAs, offering a wide selection of gold coins from around the world and expert guidance on which coins are right for you.

So why wait? Invest in gold coins today and start building a brighter financial future.