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Gold ETFs vs. Physical Gold: Intro to Gold Investment

Published by Karl Martin Karus in category Articles on 02.08.2023
Gold price (XAU-SEK)
24436,10 SEK/oz
  
- 7,90 SEK
Silver price (XAG-SEK)
309,68 SEK/oz
  
- 1,48 SEK

When it comes to investing, gold has always been seen as a symbol of wealth and stability. It attracts both experienced investors and beginners who want to protect their money. People can invest in gold in two main ways: Gold Exchange-Traded Funds (ETFs) and Physical Gold.

Let’s compare Gold ETFs and Physical Gold as investment options. Each method has its own advantages and limitations, and it appeals to different types of investors depending on their preferences, how much risk they’re comfortable with, and their investment goals.

(Photo by Jingming Pan from Unsplash)

Introduction to Gold Investments

Gold has always been a captivating investment asset, valued across cultures and generations for its beauty, rarity, and inherent worth. Even in the modern financial world, it remains essential for both seasoned investors seeking stability and newcomers wanting to protect their wealth.

One of the key reasons for gold’s enduring appeal as an investment is its status as a safe-haven asset. During economic uncertainty, geopolitical tensions, or market instability, investors often turn to gold as a reliable store of value and a hedge against inflation.

Throughout history, it has proven to preserve wealth during crises, making it a “crisis commodity” that holds or even gains value when other assets decline significantly.

Furthermore, gold’s physical existence differentiates it from other financial assets like stocks, bonds, or digital currencies. Its tangible nature offers security to those who appreciate owning something physical.

Investors concerned about the vulnerability of fiat currencies to economic fluctuations often diversify their portfolios with gold to mitigate currency risk.

In addition to its role as a safe haven, gold holds deep cultural significance as a symbol of wealth and prosperity. Across various societies, gold has been used in cultural practices, ceremonies, and religious traditions, reinforcing its intrinsic value.

This universal reverence for gold makes it widely accepted as a form of wealth sought by individual investors and central banks looking to strengthen their reserves.


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What are Gold ETFs?

If you are new to the ETF world, we recommend you read “What Are ETFs? Understanding the Basics of Exchange-Traded Funds” first.

Gold ETFs, short for Gold Exchange-Traded Funds, are a widely used and convenient way for people to invest in gold without owning the physical metal. These funds operate as open-ended or exchange-traded funds, enabling investors to buy shares that track the price movements of gold-related assets.

These shares are traded on major stock exchanges, making it easy for individuals to invest in gold without physical ownership.

Gold ETFs are designed to follow the price of real gold closely. This financial instrument lets investors take part in the ups and downs of the gold market without owning physical gold. It’s like investing in gold without storing or handling the metal.

Gold ETFs usually own physical gold bullion or assets related to gold that reflects the metal’s value they want to track. Each share of the ETF is connected to a specific amount of gold, like a fraction of an ounce, and its value moves in line with changes in the gold price.

The great thing is that these ETFs are traded on stock exchanges, so investors can easily buy or sell their shares at any time during the trading day at the current market prices. This provides a lot of flexibility and liquidity.

Also, these ETFs are very transparent in their pricing. The value of the ETF’s assets closely matches the current market price of gold, making it a straightforward and efficient choice for all types of investors, whether individuals or large institutions.

How do Gold ETFs work?

Gold ETFs work simply, blending the advantages of regular mutual funds and publicly traded stocks. They gather money from investors to buy and hold either physical gold or financial products related to gold. This creates a pool of assets representing the value of the gold they are trying to follow in the market.

Unlike mutual funds, Gold ETF shares trade on stock exchanges, offering investors the flexibility to buy or sell shares throughout the trading day at market prices instead of being limited to a single daily price like mutual funds.

The value of each Gold ETF share is directly tied to a specific quantity of gold. As the price of gold fluctuates, the net asset value (NAV) of the ETF changes in tandem. The fund’s objective is to replicate the performance of the gold price, either directly by holding physical gold or indirectly through derivatives and other gold-related financial instruments.

To ensure that the ETF tracks the gold price as closely as possible, professional fund managers carefully manage the fund’s holdings, buying and selling gold assets as needed.

Gold ETFs offer investors several conveniences and efficiencies. By investing in shares of a Gold ETF, investors gain exposure to the gold market without the need for physical storage or the complexities of buying and selling physical gold.

Additionally, trading Gold ETF shares on stock exchanges provides liquidity and flexibility, allowing investors to execute transactions quickly and at market prices. This ease of access and transparent pricing make Gold ETFs attractive for those looking to add gold exposure to their investment portfolios.

Gold ETF Pros and Cons

gold digital Source

Pros

  • Diversification: Gold ETFs offer investors an easy and cost-effective way to diversify their investment portfolios. By holding shares in a Gold ETF, investors gain exposure to the gold market without purchasing physical gold directly. This diversification can be particularly valuable during economic uncertainty when gold usually acts as a safe-haven asset, offering protection against market volatility and inflationary pressures.
  • Liquidity and Accessibility: Gold ETFs trade on major stock exchanges, providing investors with high liquidity and the flexibility to buy or sell shares throughout the trading day at market prices. This accessibility allows investors to adjust their positions quickly in response to changing market conditions.
  • Cost-Effective: Gold ETFs generally have lower expense ratios than acquiring and storing physical gold, making them an affordable way to invest in gold. The cost-effectiveness of Gold ETFs is attractive to investors seeking gold exposure without incurring high transaction costs or storage fees associated with physical gold ownership.
  • No Storage Concerns: Gold ETF investors do not have to worry about storage and security issues with owning physical gold. The burden of securely storing the precious metal is shifted to the fund provider or custodian, providing peace of mind for investors.
  • Transparent Pricing: Gold ETF shares’ value closely tracks gold’s current market price. The ETF’s net asset value (NAV) is updated frequently throughout the trading day, reflecting the changes in the underlying gold price. This transparency ensures that investors can easily monitor the performance of their investments.

Cons

  • Market Risk: Gold ETFs are subject to market risk like any investment linked to the price of an underlying asset. The value of Gold ETF shares can fluctuate based on changes in the gold price. If the gold market experiences significant volatility or a prolonged downtrend, the value of the Gold ETF shares can decline, potentially resulting in losses for investors.
  • Tracking Error: Some Gold ETFs may not perfectly track the performance of the underlying gold price. Factors like expenses, management inefficiencies, and using derivatives can lead to discrepancies between the ETF’s returns and the actual gold price, resulting in a tracking error.
  • Counterparty Risk: Gold ETFs that use derivatives or invest in financial instruments instead of holding physical gold directly may be exposed to counterparty risk. If the counterparty, such as the issuer of the derivatives or financial products, defaults or faces financial difficulties, it could negatively impact the ETF’s performance and investors’ returns.
  • Investment in Paper Gold: Some investors prefer owning physical gold as a tangible asset, expressing concerns about the paper nature of Gold ETFs. Gold ETFs represent ownership of gold-related financial instruments rather than physical gold, which may not resonate with those seeking direct possession of the precious metal.
  • Expense Ratios and Fees: Gold ETFs generally have lower expense ratios than actively managed funds but still incur management fees. These fees can impact returns, especially during periods of low or negative price movements.

As with any investment, understanding the pros and cons of Gold ETFs is essential for making informed decisions. Investors should carefully assess their risk tolerance, investment objectives, and preferences before deciding whether to include Gold ETFs in their investment portfolio. Diversification, professional advice, and a balanced approach to investing can help mitigate some of the risks associated with Gold ETFs and contribute to a well-rounded investment strategy.

What is Physical Gold Investment?

Physical gold is considered the “real” gold and has been valued for thousands of years as a sign of wealth, prosperity, and beauty. People have admired its shiny appearance, ability to be shaped easily, and resistance to damage, making it highly desired for decorations and as a form of money since ancient times.

In contemporary financial markets, physical gold remains popular for investors looking to preserve their wealth, diversify their portfolios, and hedge against economic uncertainties.

Acquiring physical gold can be done through various means. Many investors opt for gold coins minted by the government or private mints. These coins come in different denominations, sizes, and designs, often depicting national symbols or historical figures.

The most renowned gold coins include the American Gold Eagle, Canadian Gold Maple Leaf, and the South African Krugerrand.

Another option is investing in gold bars, which range in size from small 1-ounce bars to larger kilogram bars, offering flexibility to investors with different budget considerations.

Why invest in Physical Gold?

Physical gold is known for its high liquidity, making it relatively easy to convert to cash or other assets when needed. Reputable gold dealers and bullion sellers are readily available, ensuring fair pricing based on the prevailing gold market rates. This liquidity attribute allows investors to respond quickly to changing financial conditions or capitalize on potential opportunities.

One of the key reasons investors turn to physical gold is its potential to act as a hedge against inflation and economic uncertainty. Gold has a track record of keeping its value and is considered a safe choice during uncertain economic situations. When the stock market is shaky, currencies lose value, or tensions between countries, owning physical gold can offer a safe place to protect your money and help diversify your investment portfolio.

Furthermore, physical gold ownership eliminates counterparty risk, a risk associated with other financial assets that depend on an issuer’s or institution’s reliability and financial health. The investor owns a tangible asset with physical gold without dependency on a third party to fulfill obligations.

As with any investment, there are certain considerations to consider when opting for physical gold. Storage costs, security measures, and the risk of counterfeit products should be carefully evaluated. Additionally, fluctuations in the gold market can impact the value of physical gold holdings, and investors should have a long-term investment perspective when including physical gold in their portfolio.

Pros and Cons of Physical Gold Investment

Pros

  • Tangible Asset: One of the primary advantages of physical gold is its tangible nature. Investors who own physical gold have a physical asset they can hold and touch, providing a sense of security and ownership that is not present with other paper or digital assets. This tangible quality appeals to individuals who value the physical presence of their investments.
  • Safe-Haven Asset: Physical gold has a long history of being considered a safe-haven asset. During economic uncertainty, geopolitical tensions, or market volatility, gold often acts as a store of value and a hedge against inflation. It has demonstrated its ability to retain its worth and even appreciate when other asset classes experience significant declines.
  • No Counterparty Risk: Unlike many other financial assets, physical gold ownership does not depend on the stability or credibility of any issuer or financial institution. When you own physical gold, you are not exposed to counterparty risk, meaning you do not need to rely on any third party’s promises or financial health.
  • Portfolio Diversification: Physical gold can serve as a diversification tool in investment portfolios. Its performance tends to have a low correlation with other asset classes like stocks and bonds, providing potential risk reduction and improved portfolio stability.
  • Privacy: Owning physical gold can offer privacy regarding investment holdings. While some investors prefer transparency, others value the privacy of owning a tangible asset outside of the financial system.

Cons

  • Storage and Security Concerns: Storing physical gold requires secure facilities or safe deposit boxes, which may involve additional costs. Investors must carefully consider the safety and insurance of storing their gold to protect against theft or loss.
  • Liquidity Issues: Physical gold may have lower liquidity than other financial assets, especially when trying to sell large quantities quickly. Finding a buyer at a fair price might take more time and effort, particularly during periods of low demand or illiquid markets.
  • Transaction Costs: When buying or selling physical gold, investors may incur transaction costs, such as dealer premiums or seller spreads, which can impact overall returns.
  • Price Transparency: Unlike Gold ETFs, where the net asset value closely tracks the current market price of gold, physical gold prices can vary depending on the seller, location, and other factors. This lack of standardized pricing can create discrepancies in purchasing or selling physical gold.
  • Illiquid during Crisis: Although gold is often seen as a safe-haven asset, physical gold might not be easily converted into cash or other assets during extreme financial crises or economic collapses. The barter system might prevail in such dire scenarios, affecting the metal’s liquidity.

Summary of Gold ETFs vs. Physical Gold

Investing in Gold ETFs and physical gold has its own pros and cons, which suit different types of investors and their goals. The choice between the two depends on individual situations, how much risk they can handle, and what they want to achieve financially.

Gold ETFs are easy and cost-effective because they let you invest in gold without owning it physically. They offer quick access to the gold market, clear pricing, and diversification benefits, making them appealing to those who want flexibility in their gold investments.

With Gold ETFs, you don’t have to worry about storing or managing physical gold. However, keep in mind that there are still some risks involved with certain ETFs, like market fluctuations, tracking accuracy, and counterparty risk.

Physical gold has its own enduring appeal as a tangible asset with inherent value. It’s considered a safe haven and a hedge against economic uncertainties, providing a sense of security during turbulent times in the market.

Owning physical gold eliminates the risk of relying on others and offers privacy for investors who prefer a tangible asset outside the financial system. However, there are factors to consider, like storage costs, lower liquidity, and transaction expenses when investing in physical gold.

In conclusion, Gold ETFs and physical gold have advantages and disadvantages. Gold ETFs are great for investors looking for cost-effectiveness, easy access to cash, and diversification. On the other hand, physical gold appeals to those who value tangible ownership and consider gold a safe-haven asset.

Before deciding, investors should assess their risk tolerance, investment goals, and preferences. Some may choose a mix of both to get the benefits of each and create a balanced and diversified portfolio. It’s essential to seek professional advice and do thorough research to make informed decisions based on individual financial circumstances and long-term goals.

Conclusion

In conclusion, choosing between Gold ETFs and physical gold depends on individual preferences, risk tolerance, and investment goals. Gold ETFs offer ease of access, cost-effectiveness, and diversification benefits, making them attractive to investors seeking flexibility.

However, there are still risks associated with certain ETFs that need to be considered. On the other hand, physical gold provides tangible ownership, acting as a safe haven during uncertain economic times, but it comes with storage costs and lower liquidity.

To make informed decisions, investors should carefully evaluate their financial circumstances and long-term objectives, considering a mix of both options for a well-rounded and diversified portfolio. Seeking professional advice and conducting thorough research is crucial in effectively navigating the complexities of gold investments.

Gold price (XAU-SEK)
24436,10 SEK/oz
  
- 7,90 SEK
Silver price (XAG-SEK)
309,68 SEK/oz
  
- 1,48 SEK

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