Physical Gold vs Gold ETFs
The Biggest Mistake Most New Gold Investors Make… and How To Avoid It…
Many investors are aware of the way gold has performed historically and are concerned about the state of the global economy. They are also aware of the safe haven qualities of gold and feel they should be investing in gold as a means to protect their investment portfolio. Up to that point we’re on the same wavelength.
Then they make the mistake of not doing enough research. Often their research extends no further than asking their accountant or financial advisor how to ‘get exposed to gold’. And very often the advice they are given is to invest in the gold ETF, GLD.
Novice investors who rely on such advice without looking further into it are likely to be under the mistaken impression that this way they are adding real physical gold to their portfolio. What they don’t realize though, because they have not done their homework, is that this is not so. Nor are they aware that GLD carries with it a lot of counterparty risk or that GLD does not offer a lot of the wealth protection benefits that physical gold does. Let us explain more, starting with the basics….
What is an ETF?
An ETF is an investment fund (exchange traded fund) that is traded on stock exchanges in the same way that stocks and shares are. It holds assets such as commodities, bonds and stocks and in most cases tracks an index.
What is a Gold ETF?
A Gold ETF is a commodity exchange traded fund and the commodity or principal asset that it consists of naturally is gold.
An important distinction here is that when you buy a gold ETF you do not actually own any physical gold because the fund is made up of gold contracts and derivatives that are merely backed by gold. So even when you choose to redeem your ETF you receive the equivalent in cash rather than the metal itself.
When you own a gold ETF the ‘exposure to gold’ you are getting is actually exposure to gold’s performance. You are not investing in gold ‘physically’. Since the fund’s assets are supported by gold the ETF is tracking and reflecting that performance.
What is the GLD ETF (GLD)?
In 2004 the SPDR Gold Trust exchange traded fund was launched, with the ticker symbol GLD. Today it trades around 12m shares per day and in theory its share price represents one tenth of an ounce of bullion whereas in reality it tends to lag behind it by around $50 per ounce.
The purpose of its creation was to offer a cheaper way of investing in gold.
Is GLD As Good As Gold?
Another way of asking that question would be ‘Is GLD as SAFE as Gold? Owning GLD carries with it far more risk than owning the physical metal itself. That being the case you may well be wondering why financial advisors recommend it.
The simple answer is that those in the financial industry, bankers included of course, do not want you investing in gold ‘physically’ because in doing so you would be reducing the liquidity of the ‘system’. They have a vested interest in keeping the system as liquid as possible. So they advocate investing in gold stocks rather than investing in gold bullion. That’s why trillions of dollars of printed paper money have been injected into the otherwise insolvent banking system to keep it afloat.
Owning GLD carries with it a lot of inherent risk. What you are effectively doing is hedging a paper based portfolio with another paper based asset. When you buy GLD you are getting a promissory note, a promise that when you ask for it you will be given something that represents money.
When you own the actual metal itself you already own the money. Do you agree that it is better to have the money in your hand than a piece of paper promising to pay you the money when you ask for it? Not just any piece of paper by the way, but a piece of paper with all sorts of conditions and clauses written on it to protect the other party, not you! More on counterparty risk later…
You can look at it another way by taking the example of the COMEX. This makes paper trades of gold which represent in total a lot more than the amount of gold that is actually available. Should the COMEX default, GLD would be falling as fast as the price of gold was rising! In that scenario would you rather own GLD or physical gold?!
You may be thinking that the COMEX defaulting is a Doomsday scenario and of course you are right. But isn’t one of the reasons for investing in gold to protect ourselves from Doomsday scenarios? And would most people a few years ago have considered Lehman Brothers failing, countries like Greece going bankrupt or the Euro teetering on the brink of collapse no more than Doomsday scenarios?
GLD and Counterparty Risk
Most investors who buy GLD never read the prospectus. How can that be proven? Because if they did, they would never go ahead! The fine print is littered with counterparty risk. Counterparty risk has been defined as ‘The risk to each party of a contract that the counterparty will not live up to its contractual obligations’.
Just read the prospectus yourself and you will discover that the fine print gives the ‘Trust’ all sorts of ways to wriggle out of its obligations should a situation arise where it needed to.
How To Avoid The Mistake
- Do your research and due diligence thoroughly. Don’t buy the GLD ETF without reading the prospectus and understanding the risks!
- Take the least risky option and buy physical gold instead! (Click here for our Recommended Source).
To get maximum benefit from the wealth protection umbrella that gold offers, buying physical gold is a much safer option. It offers a better hedge than ETFs and much less counterparty risk. Investing in gold physically is the wisest choice.