Physical vs paper / electronic gold

Paper gold’ can be utilized as a substitute for physical gold, but it is crucial to comprehend both the advantages and pitfalls when evaluating the type of gold that aligns with your portfolio.

What is ‘Paper Gold’?

Paper gold’ can function as a substitute for physical gold, but it’s crucial to grasp both the advantages and drawbacks when determining the type of gold that suits your portfolio.

Paper gold is often more suitable for short-term speculation and may not consistently provide insurance for your portfolio or fortify your investments during financial upheavals. As illustrated by the pyramid of risk, possessing and investing in physical gold bullion is the least risky, most controllable, and least taxed (depending on individual circumstances) method to safeguard your wealth with gold.

HOW TO BUY GOLD

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Numerous investment avenues in gold exist, most of which don’t entail physical possession. Whether you invest in:

  • An exchange-traded gold fund (ETF) or a traditional gold fund
  • A mining company
  • Gold futures trading or Contracts for Difference (CFD)
  • Digital gold
  • Spread betting

In these cases, ownership of gold is typically represented on paper rather than through physical possession.

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HOW TO BUY/SELL GOLD/SILVER

Ways to invest in gold

Exchange traded funds

Exchange-Traded Funds (ETFs) backed by GOLD are funds where shares can be traded like stocks. As suggested by the name, these shares are supported by underlying physical silver reserves and follow the price of GOLD. ETFs are favored due to their high liquidity and ease of trading, but they are not without risks.

Even though you may not be able to convert your shares into silver, investors still have to trust the fund to uphold the investment. The fund is the initial counterparty that carries the risk of default, but it’s not the only one. The fund will inevitably employ a financial institution to acquire and store the GOLD, introducing a second layer of counterparty risk to the investment. Certain ETFs may even have additional layers of counterparty risk.

While GOLD ETFs do not incur spread charges, there are ongoing costs associated with holding the fund, and trading charges may apply depending on the platform and ETF used. ETFs also attract capital gains tax on the profit when sold. Therefore, when considering an investment linked to silver, the risks and costs should be evaluated in conjunction with the liquidity benefits.

Mining stocks

Contracts for difference 
  • Gold miners are another way to gain exposure to gold on the stock market. Listed mining shares are easily traded and reflect, in part, the fortunes of the gold price. But the actual spot gold price forms only a part of the value of a gold miner.
  • Investing in gold mining stocks also means investing in the proficiency of management, the efficiency of operations, and the profitability of the company. In addition, investors take on counterparty risk, country risk depending on where their mines are located, safety risk, debt risk and other organisational risks that affect the share price irrespective of how the gold price performs.
  • Mining shares are suitable for investors who want exposure to stocks that are linked to the price of gold but also reflect the corporate fortunes of the company. The highs are high but the lows can be very low, which ultimately undermines the objective of investing in gold, namely safety and security.

Digital gold

  • Digital Gold is an electronic form of currency that is based on units of physical gold. The owner of the digital gold has claim on its physical counterpart but more often than not never chooses to ‘collect’ on the gold. Instead the digital gold can be held, sold, or used to make purchases.
  • Ultimately, digital gold has to be issued and underwritten by a company or institution, and that carries substantial counterparty risk. Some digital gold is recorded in the same blockchain format as cryptocurrencies, and is held as tokens in a digital wallet and sold on exchanges. This association with cryptocurrencies may be detrimental to its reputation, but the argument is that unlike other cryptocurrencies, digital gold is backed by the physical product.
  • Other institutions are selling digital gold within their own platforms as a way for investors to own gold without the restrictions of coin or bar weight. The gold is never delivered, but is allocated to the investor as a fractional part of a larger 400 gram bar, and can be bought or sold back to the provider digitally. This digital gold relies entirely on the counterparty to uphold their obligations, and it still incurs storage fees.

Spread betting

Spread betting is another tool that enables an investor to bet on the movement of the price of gold (or any commodity, share or market) without actually ever owning it. Placing a ‘bet’ on the way the gold price will move means if it goes the right way, you can realise a profit, but by the same token if you bet wrong, you will incur losses. Investors also don’t have to cover the full cost of their ‘bet’, which means your gains can be greatly amplified, but so can your losses. Spread betting is incredibly risky and should only be undertaken by experienced investors.

Physical gold

  • While paper gold will always have a place in the investment pantheon, physical gold has many inherent advantages. Paper gold is often portrayed as cheaper and easier to own but there are usually ongoing management and trading fees for owning paper gold in the same way as physical gold incurs storage costs (unless it is delivered).
  • Investment grade physical gold is VAT free, and in currency coin format also incurs no capital gains tax. Taking delivery or utilising storage within a secure vault removes the counterparty risk associated with paper gold, removing it from the financial system altogether in a way that paper gold can never be.
  • This is one of the most important advantages of physical gold, because in the event of financial upheaval, the yellow metal still belongs to the investor. Owning the physical metal is the best way to utilise gold’s safe-haven status and ensure investors benefit from its security and long-term store of value.

A historic global currency

The enduring value of gold stems from its rarity and unchanging nature. Despite the cumulative global gold production exceeding 200,000 tonnes throughout human history, this amount, when melted down, would occupy only three to four Olympic swimming pools. According to estimates by the World Gold Council, approximately 50,000 tonnes of proven reserves remain in the ground.

This scarcity is a fundamental factor contributing to gold’s value, and it has served as a traded form of currency for millennia. In the seventeenth century, goldsmiths played a pivotal role in shaping the modern banking industry. Presently, central banks and nations are obligated to reserve a specific percentage of their wealth in gold as a safeguard against financial risks.

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