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Should I Buy a Gold ETF or Gold Bullion? A Veteran Insider Offers Pros and Cons of Each

Paper Gold

Updated on 02/07/17

Owning gold is an excellent way to diversify a portfolio.

It’s a hedge against all kinds of calamity, protects against inflation and deflation, and isn’t correlated to the stock market. Everyone should own some gold.

But what form of gold should you buy?

There are lots of options, but they all boil down to two choices: gold bullion or paper gold. Each has its advantages and drawbacks. Here are the pros and cons of each, which will help you buy the right form and meet your personal goals…

Paper Gold 

The term “paper gold” simply refers to a paper document or digital account entry that represents a gold holding. Examples of paper gold include bullion exchanged traded funds, mint certificates, pool accounts, and futures and options. It is any form of gold where you don’t have ownership of physical metal.

Many of these paper products were created as a convenient way to gain exposure to the gold price without having to buy physical metal, take delivery, and arrange for storage. Like all investments, you will realize a profit or loss when you sell.

Another advantage is that paper gold can be a very low-cost option.

The primary drawback with all forms of paper gold is this:

You don’t own the metal.

This often means that you can’t take delivery—or if it’s available it is usually very expensive.

Paper gold also carries counterparty risk. This essentially means that you must rely on a third party to make good on a contract. Fraud, mismanagement, delivery failure, and other issues are possible. Threats like these are not common, but they have all occurred and their risk is not zero.

Here are the most common forms of paper gold, along with their pros, cons, and suitability…

Gold Exchange Traded Funds (Gold ETFs)

An ETF is an investment fund that trades much like a stock. For a bullion-backed ETF, the fund’s share price tracks the price of gold. And the fund will hold physical gold that backs each share of the fund.

Bullion-backed ETFs are convenient and low cost. However, you don’t own any portion of the gold that backs the fund’s shares.

The largest gold ETF—SPDR Gold Trust (GLD)—does not buy and sell gold. It creates and redeems paper shares in the company, which are passed through a group of market makers that trade them on the NYSE. A corresponding amount of physical bullion is then deposited into or withdrawn from the fund’s vault in London, operated by custodial bank HSBC.

So if you buy shares of GLD, you’d don’t own the metal or have any claim on it. To take delivery requires a minimum 100,000 shares—at $1,000 gold, that’s $1 million! The fund also has the right to settle a physical delivery request in cash.

Other bullion-backed ETFs work similarly. Some smaller funds permit delivery of as little as one ounce, but it’s expensive and delivery is not prompt.

Counterparty risk is also present, such as mismanagement of the gold company, custodial fraud, or delivery failure. It’s important to realize that these risks would heighten in a period of financial crisis.

As such, a gold ETF would not act as a financial backstop during a personal or economic emergency. This is the primary advantage of owning gold bullion, which you forego with paper gold.

One last advantage is that you can usually buy options on an ETF. While this generally entails a higher degree of risk, gold bullion itself does not offer this type of leverage. Traders will use paper forms of gold for this purpose.

Pros and cons of bullion ETFs

Pros Cons
Will track the price of gold No ownership of gold bullion
Convenient to own, inexpensive to buy No option to take delivery
Can use options to attain leverage Counterparty risk

Suitability: Bullion ETFs are ideal for someone who wants a low-cost way to invest in the direction of the gold price, or wants to employ leverage with options. They are designed for the investor that doesn’t want delivery now or later, and is comfortable with counterparty risks.

To choose the best ETF see our article on where to buy gold.

Pool Accounts/Fractional Ownership

A pool account is where your investment dollars are “pooled” with other investors to buy gold. You essentially own a fraction of a gold bar.

Like ETFs, these programs are usually convenient and cheap. Storage is also inexpensive, and in some programs it’s free.

Also like ETFs, you don’t own the gold. For programs that advertise “allocated” gold, it means that the metal is allocated to the company, not to any individual investor.

Some programs offer delivery, but it’s expensive; you must first pay a fabrication fee, which can exceed the premium you would’ve paid for the gold in the first place, and then add a delivery fee.

You are also exposed to counterparty risk. Should the company become insolvent or bankrupt, you become an unsecured creditor. You may never receive your gold or even the return of your money. And the recovery process could take months or years to complete.

Pool accounts were popular in the early 2000s, but their popularity has waned. Today, a greater selection of options to buy and store gold is available.

Pros and cons of Pool Accounts

Pros Cons
Trading costs are very low No ownership of gold bullion
Storage is inexpensive (or free) Fabrication and delivery is expensive
Delivery is optional Counterparty risk

Suitability: Pool accounts are best for investors who want a low-cost way to buy and store gold, with the option to take delivery someday (though it is expensive).

Learn how to choose the best pool account in our article, Where to Buy Gold: The 6 Best Options with Pros and Cons.

Now let’s compare paper gold to physical gold ownership…

Gold Bullion

Gold bullion refers to any form of physical gold that you can hold in your hand. Even if stored elsewhere, it is specific pieces of physical metal held in your name and title. It is not a paper representation of gold, but actual bullion you own outright.

Purchase costs are higher—though not as high as many believe—but you avoid the potential risks associated with paper gold.

The primary advantage of gold bullion is this:

You can never suffer a default.

That’s because gold is the only financial asset that is not simultaneously someone else's liability. Once you own gold bullion, it’s yours!

Gold bullion doesn’t require the backing of any bank, government, or brokerage firm. It cannot suffer a default or its value falls to zero.

No counterparty risk means that once you have physical gold in your possession, you don’t depend on someone else to fulfill a contract or keep a promise for it to retain its value.

Stocks, bonds, ETFs—essentially all paper assets require another party to uphold their end of the deal. Not so with a gold Eagle in your hand.

Gold is the ultimate form of long-term value. You can leave it to your kids, and it can be sold for currency literally anywhere in the world.

Here are the advantages gold bullion offers over paper gold…

Gold bullion has no...

  • Time limit (it will outlive you!)

  • Shelf life (it never rusts)

  • Counterparty risk (remember bank customers in Greece and Cyprus?)

As money, gold bullion is...

  • Liquid (easily convertible to cash)

  • Portable (you can hold $50,000 in a single hand)

  • Durable (you can leave it to your kids and grandkids)

  • Value dense (high value held in a small quantity)

  • Private and confidential (you control who knows you own it)

Gold bullion cannot be...

  • Printed (it takes a mine 10 years to go from discovery to production)

  • Counterfeited (you can try, but technology will catch it every time)

  • Inflated (it can't be reproduced by the whim of a central banker)

Gold is valuable because it has intrinsic financial traits that no other asset does! These are the reasons to consider owning gold bullion instead of paper gold. Find out why gold has remained valuable since it was first discovered in our article, Why is Gold Valuable? The 5 Reasons Most Investors Overlook.

Pros and cons of Gold Bullion

Pros Cons
No counterparty risk, no risk of default Premiums to purchase are higher
Portable, durable, and value dense Must pay for delivery
Can be private and confidential Must arrange for safe storage

Suitability: Gold bullion is ideal for investors who don’t want to worry about counterparty or default risks. It can be used no matter where you live, will outlast any paper form you buy, and can be kept confidential from other parties.

Final Recommendation

Based on my experience working in the gold industry for over a decade, I tell investors they should initially favor gold bullion over paper gold. Everyone should start by purchasing some gold Eagles or gold bars, given all the advantages outlined above.

A bullion ETF is a great way to play the gold price, but gold bullion should be purchased for any long-term holdings.

If you decide to buy gold bullion, see our article on how to buy gold bars for actionable advice.

After you accumulate a few ounces of gold, you’ll need a secure place outside your home to store them…

It’s a good idea to keep some gold bullion at or near home—you want quick access in case of an emergency. But keeping more than a few ounces in the house greatly raises your risk—theft, fire, or even misplacing them are all real concerns.

And a safe deposit box at the local bank offers no insurance against theft or natural disasters.

The best solution is to own and store gold in a fully allocated account, outside your home and the banking system. The Hard Assets Alliance (HAA) offers safe and secure domestic and international bullion storage service, and removes all of these risks.

In fact, HAA uses the same vaults that are used by major financial institutions from around the world.

Check HAA’s network of dealers that offers among the most competitive pricing available in the industry.

Free Ebook: Investing in Precious Metals 101: How to buy and store physical gold and silver

Download Investing in Precious Metals 101 for everything you need to know before buying gold and silver. Learn how to make asset correlation work for you, how to buy metal (plus how much you need), and which type of gold makes for the safest investment. You’ll also get tips for finding a dealer you can trust and discover what professional storage offers that the banking system can’t. It’s the definitive guide for investors new to the precious metals market. Get it now.

 

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