Gold is attractive. It has drawn the worship of the Incas, hundreds have flocked to uncharted territory to mine the shiny flakes, kings and queens have gilded their homes, and it has acted as a form of currency since 1500 BC. This allure and desire for gold has not been lost. This yellow metal is still widely used in jewelry, electronics and computers, dentistry, medicine, and as a monetary and financial staple. Gold is quite rare, and as such, it is highly valuable. Gold has found its place as a worthwhile investment. There are many reasons to invest in gold. Gold acts as a hedge against the stock market. It protects against inflation and deflation, and the printing of currency. It is a safe-haven during times of political and economic uncertainty. The gold market is highly liquid and there are many ways in which investors can gain exposure to this precious metal, including holding physical gold (i.e., gold coins and bars) and exchange traded funds (ETFs).
Physically owning gold offers many benefits over investing in a gold ETF. Gold ETFs, consisting of the one principal asset, track and reflect the price of gold. While the assets in the fund are backed by the commodity, the intent is not for an investor to own gold. A gold ETF only gives an investor an opportunity to gain exposure to the performance of gold, but this means that you end up with a position. It becomes a number that you trade into and out of based on extraneous factors that may or may not influence the underlying price. You don’t have the tangible asset in your hands. There are some ETFs that are backed by physical gold, but for most you cannot redeem or sell shares in exchange for gold. For ETFs that allow you to take delivery of physical gold, the requirements are quite steep. For one of the top ETFs, you must own at least 100,000 shares, and the delivery will be in 400 ounce bars, and the fund retains the right to settle in cash for any reason they deem necessary. 400 ounce bars equal about $480k each at $1200 gold, and this is beyond the reach of all but the most successful individual investors. ETFs are part of the stock market, which invalidate using a gold ETF as a hedge or safe-haven from the market. If the stock market goes south, all your paper investments will become just that – paper.
Buying physical gold offers investors many protections. Physical gold will always have its intrinsic value. Physical gold provides the most direct exposure to gold. Gold in bulk form is referred to as bullion, and it can be cast into bars or minted into coins. Gold bullion’s value is based on its mass and purity rather than by a monetary face value. Even if a gold coin is issued with a monetary face value, its market value is tied to the value of its fine gold content. Physical possession of gold helps mitigate the real fears of financial institutions’ scandal and wrong-doing. Holding the paper proxy for gold has risks as you rely on a third-party; bad management, regulatory oversight, lack of safeguards, and operational integrity can all be compromised. While unsubstantiated, skeptics have even raised doubts over the management of physical gold for funds, with questions over how much physical gold bullion is actually held[i]. For some investors, gold is appreciated as the perfect investment in the event of massive economic hardship. If you own physical gold, it can be relatively easy to carry it around, is easily liquidated anywhere in the world, and can even be used as currency in many situations.
There are costs associated with investing in gold. With a gold ETF, an investor will lose a percentage of his or her investment’s value each year to the fund’s expense ratio, which is the recurring annual fee charged by funds to cover its management expenses and administrative costs. There will also be the commission for buying and selling an ETF, and an active trader can easily rack up high costs. For physical gold, there are three principle costs, including storage, insurance, and transportation. For insurance, the cost is dependent on the volume of gold you own, but for storage and transportation the costs are less influenced by minor changes in volume. If you are buying gold long term, in large volumes, and you plan to keep on adding to that volume in good quantities, both storage and transportation costs will go down on a per unit basis. Conversely, ETF management fees are dependent on volume/value. For privately stored physical gold, there are low to no reporting requirements, though capital gains tax will need to be paid if you sell. However, taxes, security and holding costs aside, for a long-term investor looking for a hedge to the portfolio, physical gold is the ultimate solution.
[i] http://www.forbes.com/sites/afontevecchia/2011/11/15/is-gld-really-as-good-as-gold/#757d0a533ca1
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