It is better to invest in physical gold than a gold ETF

The increased interest in investing in gold following the Corona crisis sharpens the question: What is the most worthwhile channel for making the investment? We have summarized for you the notable differences between purchasing physical gold and investing in gold ETFs and derivatives.

Assets made of gold such as bullion, collectible coins or jewelry, were created from a rare raw material. However, most trading in the gold market is conducted indirectly and through speculative assets, which usually do not include a significant holding of physical gold.

Gold ETF – a riskier investment than you thought.

Indirect trading in the gold markets is partly conducted on the commodity exchanges in London and New York, through futures contracts and options, or through ETFs on gold that are traded on the regular exchanges. There are big differences between the various financial instruments that track gold, and some offer affordable and liquid investment options. However, it is important for every investor in the field to recognize an essential characteristic that distinguishes them from the purchase of physical gold: the investment in such financial instruments is made through intermediaries, removing the investor from ownership of the metal itself and exposing him to a series of risks arising from this.

The physical gold: rare, stable and mobile

Unlike gold ETFs or other investment instruments, investing in physical gold is much safer.

A main reason for the unique value of gold, an advantage that has proven itself for thousands of years, is the rarity of the shiny metal. Around 190,000 tons of gold have been mined in the world to date, and according to estimates, only another 50,000 tons of unmined gold lie in the ground. This rarity distinguishes gold and other precious metals from most other investment avenues. The meeting between the constant demand for assets made of gold and the limited supply of the metal ensured the stability of the prices of these assets in the past and is expected to do so in the future as well.

Holding assets made of physical gold, such as coins, bars or medals, gives investors a direct connection with the rare metal and of course the possibility to move or sell it anywhere in the world and at any time. Most of the assets in the gold market, which as mentioned are only derived from the price of physical gold, do not provide these significant advantages.

The unrestrained money printing of central banks in the world following the Corona crisis increases the influx of gold. Goldman Sachs economists recently wrote: “Gold is a currency of last resort, especially in the current environment, when governments are eroding their currencies and pushing interest rates to all-time lows.”

The well-known investor Warren Buffett, who for decades was a prominent opponent of investing in gold, changed direction following the recent events. His investment company, Berkshire Hathaway, bought shares of a gold mining company for about half a billion dollars. Ray Dalio, the founder of Bridgewater, one of the largest investment companies in the world, put it bluntly last year when he said: “Cash is garbage, too much money is held in cash. In my opinion, it is necessary to have part of the investment portfolio in gold” – when it is aimed mainly at the physical gold.

The disadvantages of gold ETFs and derivatives over physical gold

Gold ETFs are a common and available investment instrument that should be linked to the price of the metal, but in fact, some do not buy gold at all. Many investors in Israel are not aware that all the gold ETFs traded on the local stock exchange do not invest in the physical gold itself in a significant amount. Even the foreign ETFs that invest a significant part of their assets in actual gold bars, still cause two substantial risks for the investor, which we will detail now.

Third party risk

A fundamental reason for investing in gold is that it is an independent, safe and mobile asset. Investing in gold is a kind of “insurance certificate” against unexpected events in the economic and political world: rampant inflation, financial crises, bankruptcy of governments and more – events the likes of which we have seen in the past and will likely experience in the future as well.

In gold derivatives, the investor depends on the intermediation of various institutions, which are exposed to their own business problems, changes in the regulatory environment and many other challenges. Therefore, investing in derivatives on gold, such as ETFs or options, is not as safe as holding physical gold in the hands of the investor.

market risk

Since physical gold constitutes only a single percent, and possibly even less, of the derivatives market on gold – there is a possibility, even if the probability of it is currently low, for a crisis to arise if many of the holders of the derivatives seek to realize their investments at a certain moment. This requirement is obviously impossible, due to the ratio between the limited amount of physical gold and the enormous value of the derivatives.

In the past, there have been similar events in the markets where the silver metal is traded, which ended in an aggressive intervention by the United States government, which came to the rescue to protect investors. The main victims in the case of this type of upheaval are expected to be the buyers of derivatives on gold, while the holders of physical gold will benefit from relative protection, and perhaps even a rise in the value of the metal in their possession as a result of such a crisis.